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2008 Corporate Governance Summit
Event Summaries
Lessons Learned
Bob Eckert, Chairman and CEO, Mattel
Bob Eckert noted that his experience with Crisis Management 101 starts with Summer
Vacation—the same camping adventure as he had for the past 51 years. Last year, in the
summer of 2007, that camping adventure lasted all of two days as Mattel faced a class
action lawsuit due to the company’s import and sale of faulty toys manufactured in
China. That quickly turned into a media frenzy, which included Senate Hearings and
interviews on live national TV.
As a company, Mattel draws on a global supply chain with the majority of its 8,000 toys
manufactured in China. About 80% of the product line turns over annually. Every year 2
or 3 toys get recalled due to small parts that can cause choking or quality issues. 2007
was different.
The toy recall started with Mattel’s competitors, RC2 and Mega Brands. RC2 found lead
paint on its Thomas the Tank Engine. Mega Brands found that small powerful magnets
on their Magnetix Building Sets had caused the death of a child who had ingested two
tiny objects sequentially when these tried to connect. The two events set off a series of
toy recalls.
Mattel first recalled 83 products that had failed safety tests for lead paint in Europe on
August 2, 2007. A second recall followed August 14, when an additional lead paint
related toy was withdrawn as well as over 70 magnet toys. The key was to get a message
out telling people to return their older toys. Google, Yahoo, and other video outlets were
flooded with videos to reminding parents that safety remained Mattel’s number one
priority.
The second recall was the major issue for Mattel. August is a significant shipping month.
The entire shipping line had to be stopped as ½ billion toys were tested and more issues
found. Mattel faced an environment where the company was faced with consumers and
lawmakers expecting them to take responsibility along with a media environment that
saturated news programs with the Mattel story as the lead. Mattel had to act fast to
reclaim traction with consumers, lawmakers, and other stakeholders, which ended in
praise for the way that the company handled the situation from Senator Dick Durbin (DIL) at the end of an extended C-SPAN hearing.
What then, were the main lessons learned? Above all, Bob Eckert reminded the audience
that the most important thing in a crisis situation is to be straight about it and be quick
about it. The key is to acknowledge the situation and to acknowledge what will be done
about it. To that end, he added several key lessons to take away:
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USC Marshall School of Business
2008 Corporate Governance Summit
Event Summaries
1. Have a crisis plan in place in advance. That means knowing who to call, knowing
who speaks for the company, and how that person will speak.
2. Teamwork is a must. Everyone has to be on board and silos only serving to
increase finger pointing prevented. As Eckert observed, crises will show who is
“on the bus” and who is not.
3. Stick to daily meetings at set times. Mattel’s leadership would meet twice daily at
7 am and 4 pm, 7 days a week. Sticking to the schedule meant that globally,
everyone had the same information and was able to engage on an equal basis.
4. Communication consistency is key. The same people need to unfailingly reinforce
the same messages to the public. In Mattel’s case, the spokesperson was Eckert
himself, who emphasized the need to consistently a) apologize to the parents, b)
explain the problem, and c) let everyone know what is being done to prevent
future incidents.
5. Determine who really steps up. Forced rankings before and after the toy recall
might now show an acid test for performance
6. Create partnerships in running the business and crisis management that function
behind the scenes while the spokesperson operates in the open.
Eckert emphasized the success of Mattel’s handling of the situation by way of the
company’s 2007 results. Not only did the majority of the general public believe that
Mattel handled the situation well, but an important constituency, the employees were
resurveyed by Fortune to determine that Mattel should stay on the list of Top 100
companies to work for.
Eckert finally recognized the important role played by Mattel’s Board of Directors who
provided the oversight and support needed to succeed. He called every Director who
returned his phone calls and provided sound advice by being able to step back and give a
fresh perspective on the situation.
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2008 Corporate Governance Summit
Event Summaries
Special Committees
Panel moderated by Rich Corgel, Ernst & Young LLP
Rich Corgel, Executive Director in the Fraud Investigations and Dispute Services
practice of Ernst & Young LLP moderated a discussion of special circumstances that
require special committees to engage in discussions that requires the ability to think and
act independently. Special committees often face specific responsibilities and challenges
that were addressed by the panel.
David Schindler of Latham & Watkins stated that special committees can be divisive,
but needed when there is a lack of directors to focus on issues independently. There are
three general areas where special committees are used:
• Option stacking and investigation of special issues that are individually
segregated
• Transactions involving the company itself that need to be protecting shareholders
• Day-to-day issues that need to take advantage of the expertise of the Board
There is a question of what is actually deliverable of a special committee. Drawing on the
keynote by Mattel’s Bob Eckert, Schindler suggested that circumstances when special
committees are warranted would include the event that allegations surfaced suggesting
that Eckert knew about the leaded paint and that someone served as a whistleblower to
the Board. Companies have whistleblower hotlines and anonymous tips emerge that are
directed through the food chain, but these may present a problem because of the question
of when to investigate individuals. Special committees face difficult issues and to focus
on deliverables may be problematic. Schindler observed that there are circumstances
when the less that is written the better since writing is discoverable and will be subjected
to a microscope.
The mission of the special committee is to find a focus and to fix it. Constituencies will
be asking for written report. There is a rule of proportionality—the Committee has to
devise a plan for reasoned judgments along the way. When members of the Committee
bring special skills, they can be expected to face added scrutiny if they do not speak up.
Ben Buettell, Managing Director and head of the Financial Opinion and Advisory
Services Group in Houlihan Lokey’s Chicago office pointed to Rule 2290 by looking
back at 2003 when investment banks made money on fairness. Then Spitzer dropped off
and in 2004 the FDIC decided to take a closer look leading to changes effective
December 2007. The main issues that the Rule is trying to address include disclosure of
certain items, procedural issues and contingent compensation, requiring explanations of
how and why executives get paid. Material relationships used to be disclosed earlier.
Now there is an expectation of added disclosure of relationships with counterparts or
sales to provide shareholders with the opportunity to verify information.
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Event Summaries
Companies now have to disclose in depth information for verification. Compensation in
addition to per share must be investigated and noted. Special committee members have to
be on top of this and the procedural requirements. For example, is there an in house
fairness committee? There is a special process that moves information up front and that
requires internal and external scrutiny, as well as occasionally a second opinion.
Peter Nolan, Managing Partner of Leonard Green & Partners, noted that special
committees become a question of public vs. private—most CEOs do not want to be
public because of the increased liability that comes from knowing something. Most
Directors are brought in without knowledge of the actual business of the industry.
One important thing is that Directors have to act like an owner. Conflicts may require
special committees, but may set off unclear reactions within the case. Shareholders may
lose voice without special committees.
The regulators have shifted outside responsibility to special committees and Boards, so
they can be very divisive. What happens when it is done? There are hidden costs of
relationships that may not emerge until after the fact.
Discussion followed, noting that best practices are key, especially when something could
be discovered. Peter Nolan pointed out that it is important to ask what happens long term
and that when something happens there is often something that should have been
discovered. A specific point of discussion surrounded Bear Sterns. Ben Buettell
recognized that the truth surfaced so quickly that it is hard to know what happened, while
Peter Nolan felt that the immediate question was when the shareholders were brought in.
The question is also of the value of Bear Sterns’ assets. The panel agreed that things will
continue to unfold and be revealed, and that there may be significant litigation ahead.
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Crisis in the Corner Office
Panel moderated by Bill Coffin, CCG Investor Relations
Bill Coffin, CEO of CCG Investor Relations moderated an interactive panel on CEO
turnover trends and the Board’s role in the process. The last 5 years have seen
unprecedented turnover. In 1995, Coffin said, the average tenure of a CEO was 12 years,
while in 2007 that was down to 5 ½ years. Meanwhile, compensation has increased to
over $15 million per year. The question is also whether the media has added pressure on
CEOs and whether the complexities are greater than before.
Mark Collinson also of CCG Investor Relations, noted that there are several issues
facing the three pillars of organizations—Board of Directors, shareholders, and the office
of the CEO. First, the blood supply of new CEOs has deteriorated. CEO incentive
packages encourage CEOs to take risks, they receive options that make them huge
amounts of money, and when they fall down, they can return to the headhunter.
Previously what was valued was the status, high pay, and longevity in the position. The
agenda has changed as shareholders swing for the fences. There is a divergence of
agendas and the role of the CEO has become unglued from the three pillars.
Second, it used to be that CEOs had to be adapted, but now they have to be adaptable.
There are too many challenges facing CEOs, including globalization, the environment,
technology, and when they are not adaptable there will be turnover. Most are unable to
deal with the massive changes that are taking place in technology.
Mark Nadler, Partner at Oliver Wyman, Delta Organization & Leadership LLC,
presented four reasons for the turnover while noting that the statistics to a certain extent
contradict each other:
• An increased merger/acquisition climate that eliminates many CEO offices
• Shareholder activism exerting more influence and pressure on non-performance
• A small but increasing number of CEOs are more engaged in conflicts with their
Boards
• Increasing complexity of the job itself, which is changing rapidly
Many CEOs are brought in to fix something, but after Act I, they often lack important
skills needed for Act II.
Allan Rudnick, Family Offices LLC, identified two reasons for the increase in turnover:
• Investors, since the role of shareholder has changed, they have moved to more
activist campaigns
• Complexity that is too great for the person in the CEO office. That is alongside
with expectations for quarterly predictions, which are followed by the need to
fulfill those often lead to poor longer-term decision making.
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2008 Corporate Governance Summit
Event Summaries
Rather than understanding the focus of the business and the complexity of the global
technological environment, the focus is on making and exceeding numbers.
Bill Coffin raised the issue of short vs. long term strategies, including what is cut short
by activist shareholders.
Allan Rudnick pointed to the GE board where the CEO compensation package was
adopted for 6 years, but arrogance and an imperial CEO led to frustrated shareholders
stepping in.
Mark Nadler felt that death notices of old style and birth announcements of new style
CEOs may be premature. There is a shift, but the press likes to see imperial CEOs leaving
office. Still, over half of all companies do not have a strong CEO succession plan and
even fewer do in private corporations. Many directors would like to see a more driven
CEO succession plan, but it still often boils down to CEOs choosing their own successor.
Allan Rudnick agreed, noting that media often projects CEOs as imperial leaders
whether that reflects the reality or not. Every strategy needs a strong leader.
Mark Collinson pointed out that in service industries, succession planning means that
Directors need to step in and smooth over the transition by understanding who the future
leaders are. CEOs too often continue to fire those who are next in line.
Mark Nadler noted that CEOs sometimes can be seen as serial succession killers. They
are experts at grooming the new, but cut them off when they are ready to take over so the
process has to start all over. A crucial area for the Board is to keep an eye on succession.
Many CEOs find it emotionally draining. It is a tough emotional thing, especially for
CEOs nearing retirement because their identity is so closely tied to the role. It is
important to keep an eye on CEOs so that they do not sabotage. Often when CEOs bring
in consultants for succession planning, the initiative shifts to the Board, which is
increasingly the source of the process. That is the role of the Board in governance.
In all, it is better to have a name than a horse race. A mature CEO who informs the Board
of their plans can keep a strong successor in the mind of the Board. If the horses are
internal then there is usually a lot of political jockeying.
Allan Rudnick pointed out that GE knew in 1994 that Jack Welch would retire in 2001
and started with a top list of 26 people that dwindled to 3, all of who knew that they were
finalists. There were clearly stated assumptions behind the decisions:
• The successor would be GE’s unquestioned leader, therefore two would have to
leave
• Each of the three would choose their own successors
• The people chosen were selected away from the home office
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Event Summaries
•
•
All chosen had to attend social events with the Directors to get acquainted
The person chosen would be young enough to stay for at least a decade
Mark Nadler observed that most companies cannot afford to lose two out of three
leaders. The public nature of GE’s horse race made it very political.
There is a significant gap between Acts I and II. There needs to be a range and
opportunity to hire someone for the long term or short term if the intent is to fix an
immediate problem. The position would be project based, or someone from the Board of
Directors could be brought in.
Boards are becoming more involved in succession planning. It is the Board’s
responsibility as long term stewards. Off-the-shelf criteria for good CEOs do not work;
the CEO has to fit with this company in this strategic environment within this particular
culture of the company. The system will reject transplants that don’t fit, so the Board has
to either find someone who does fit or who will shift things just slightly without anything
breaking.
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2008 Corporate Governance Summit
Event Summaries
The Current Market, the Economic Conditions, and the
Implications to Directors
Michael Tennenbaum, Senior Managing Partner, Tennenbaum
Capital Partners LLC
Tennenbaum noted that there are two aspects that companies need to pay attention to:
solvency and juggling corporate assets. Boards are generally more protective of their own
assets and liabilities in large public companies. They have a duty to maximize values in
the short term, but also to consider longer term strategies.
Shareholders cannot complain unless there is absolute insolvency. There is considerable
personal risk if shareholders are swinging for the fences. The current context of
shareholder activism has not existed since the 1980s. Large institutional shareholders
have adopted activism, especially when shareholder peer pressure increases. Small
shareholders with access can implement nonbinding shareholder proposals.
The biggest institutional equity holders in the US are voting according to ISS proposals.
The change is that some of the important ISS proposals have led to Board votes being
impacted. The Board may fail to act or vote against, or withhold proposals to classify or
repeal. The Board may vote by case on elections and proposals in conjunction with
dissidents; vote against restrictions to hold meetings for the ability to act; or vote against
or withhold composition of the Board or CEO if the compensation or equity plans are
poor. Bear Sterns is an example of a culture as well as a character. Leaders who snub will
get similar treatment, yet it is sad to see the company go.
Boards need to introduce chewable pills that have a limited life but foster options for the
company without being totally opposed to the action to be taken. Overall relief from
entrenched management is long overdue.
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2008 Corporate Governance Summit
Event Summaries
D&O: What Directors Should Know
Panel moderated by Chris Crawford, Willis Executive Risks
Chris Crawford, Senior Vice President and Regional Practice Leader with Willis
Executive Risks, moderated a panel on D&O liability, noting that while recent headlines
are playing out, D&O litigations typically take 4-6 years to play out so it will take time to
know how the sub-prime settlements related to homebuilding and other real estate, for
example, will turn out. What is clear is that the median settlement as indicated by
percentage of estimated damages by year would go up. Significant is also that three of the
top settlements in 2006 involved non-US companies, tripling the previous record by a
foreign issuer, while the average and median settlement values reached new highs in
2007 (increasing by 34.4% and 37.1%, respectively). There is an increase in the number
of Class Action Securities cases involving companion derivative claims in recent years.
The change is largely driven by institutional funds. An institutional investor increasingly
plays the role of lead plaintiff. There has been a plateau of the number of lawsuits filed
annually, with a decline throughout 2007. In July and August of 2007, the sub-prime
interest started going back up. The previously favorable D&O environment started
changing and is starting to become more restrictive. A 2006 Korn/Ferry survey indicated
that managers are increasingly turning down positions because of potential liability
concerns, while Directors are less likely to join or continue on Boards for organizations
lacking in D&O insurance.
D&O consists of three parts (A, B, & C sides): A) non-indemnifiable (oneself as an
individual, requiring personal asset protection for executives); B) indemnification—
corporate reimbursement coverage (balance sheet and the company, leading to corporate
risk transfer); and C) indemnification—corporate entity defendant coverage for securities
claims (compliant, requiring significant defendant allocation coverage). Adding nonindemnifiable coverage for personal assets is important for the individual’s personal
comfort level and the ability to stay solvent for the 4-6 years or more that litigation takes.
Severability in this context means ensuring that if someone acted fraudulently, they are
unable to implicate others who were unaware of the situation. Key D& O coverage issues
include:
• Severability—conduct exclusions and application
• Personal conduct exclusions
• Coverage grants for sections 11 and 12
• Non-rescindable A-side (non-indemnifiable) DIC coverage
• Affirmative non-rescindable A, B, & C coverage in the primary
• Priority of payments provision
• Investigative costs coverage for derivative demands
• Insured vs. insured issues
• Multinational D&O liability issues
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Multinational D&O is increasing and growing in visibility, but is complicated. One may
have to pay local taxes and have an understanding of local issues, as well as to know if
US companies can respond to issues overseas.
David Siegel, Managing Partner of Irell & Manella LLP, stated that filings of Class
Actions were down over the last three years. Derivative lawsuits were up, with 170 filed
in 2006 (these were multiple law suits). Securities loss has led to increased SEC exposure
and Department of Justice activity.
Siegel identified five issues to consider:
• SEC and DoJ activity in interaction and supervision, including rulemaking on
compensation disclosure and violations of the Foreign Practices Act
• Increase in shareholder activism as the biggest losers in stock drop markets,
means that shareholders will go after individuals for monetary compensation
• Risk disclosures and financial misstatements have led to a rise in restatements and
changing relationships with auditors. The GAO estimates an increased volume in
restatements from around 1390 between 2002 and 2005 to over 1500 in 2006
alone
• Foreign companies doing business in the US are sued for “your” interests. In 5
years, the number one securities litigation market will be London, leading to risk
exposure that is global in nature
• Costs of settlement values are rising. The early stages cost millions of dollars. The
government is looking over shoulders and e-discovery is increasing
These trends mean that some individuals will opt out or become more expensive to keep.
Adding corporations to the coverage is expensive. Aggregate coverage may reach $100
million for each individual. Individuals and corporations may end up hiring different law
firms. Policies need to cover civil and criminal defense costs. When sentencing is
considered the final adjudication, that money gets eaten up very quickly. Additionally,
the D&O aggregate can disappear quickly if a new Board steps in.
Evan Rosenberg, Senior Vice President of Chubb & Son, noted that if the insurance is
bought in $10 million blocks, each block needs to be committed individually to be
accessible from a capacity stance. When it comes to choosing an insurance company it
therefore is important to look at the track record of the company’s claims history.
Products do exist for writing policies for independent Directors and personal Director’s
policies. Insurance products are available but not always purchased. While many people
assume that a personal umbrella policy on a home insurance will suffice, it does not cover
personal liability.
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2008 Corporate Governance Summit
Event Summaries
Audit Committee
Panel moderated by Bill Holder, USC Marshall School of Business
Bill Holder, Ernst & Young Professor of Accounting at the Leventhal School of
Accounting at the USC Marshall School of Business, moderated an interactive discussion
on audit committees.
Dennis Beresford, Ernst & Young Executive Professor of Accounting, J.M. Tull School
of Accounting, Terry College of Business, University of Georgia, discussed the
importance of the right people on the audit committee, procedures to make sure that it is
effective, overseeing internal and external audits, and a few overall tips. At least one
committee member should be able to speak “GAAP” and be familiar with FCC, SEC and
other institutions.
Continuing education is important. It is important to provide feedback for mutual
learning among all parties. The audit committee hires the outside auditors under
Sarbanes-Oxley, but the determination of the appropriate fee continues to be a problem.
Outside auditors have no restriction on the amount that is felt to be appropriate, but you
don’t want to give them a blank check. Stating the number of hours helps to evaluate the
fairness of the fee. The fee is often expressed as discounts from standard fees. The rate
per hour should be commensurate with other projects for that accounting firm in that
environment. Overseeing external auditors means good ongoing communication with the
externals to make sure that the CFO is in the loop. Outside auditors also need to improve
their communication, since many reports become so routine, that it is hard to know what
to look for. The audit committee should not oversee the internal auditors’ compensation,
etc. Even the best can miss inappropriate readings of generally accepted audit principles.
Audit committees need to pay attention to disclosure committees and other aspects of the
business. The audit committee’s relationship to the compensation committee is to be sure
that the information of the proxy statement is correct and reasonable. At some point, there
will be restatements of proxy statements as well.
Summary suggestion questions to discuss in audit committee meetings:
• Do you understand the company’s critical accounting policies and reporting? How
do those benchmark against other companies? Has the audit committee had a
detailed discussion of policies recently?
• Do you understand the most critical accounting estimates? What could go wrong
or right that could materially change these estimates? Do you understand how fair
value is determined and is this a critical accounting factor for the company?
• Are there any other estimates, policies, or transactions for which external audits
need to consult with the national office? Ask for the company’s documents to get
a better understanding of the issues.
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•
•
•
Is the FCC asking anything in particular about the company’s filings?
Is what the CEO and CFO telling you about the financial standings
understandable? This should be in plain English and easy to understand. If one
Director doesn’t understand something, then others probably do not either.
Is the company giving financial analysts and other key constituents the
information that they need?
Gerard Miller, former President of the Janus mutual funds and Chief Operating Officer
of the Janus Capital Group, Inc., pointed out that governance is key before noting that it
is important to know something about the players. First and foremost, the players include
the Board, the shareholders and investors, regulators, and fellow audit committee
members, and employees.
The Board is relying on the audit committee to get its work done. Especially lay members
of the Board need to rely on the audit committee to communicate the scope, timetable,
important findings, and so on. That is probably more important than many audit
committee chairs are willing to let on. Shareholders and investors expect independence
and vigilance. Only the audit committee stands between them and management; that
places the audit committee in a fiduciary role. Periodically, the audit committee probably
should have a conversation with counsel about roles and responsibilities. Sarbanes-Oxley
has laid out the expectations for qualifications—everyone needs to watch each other’s
backs when it comes to qualified experts.
The regulators—FCC, States Attorneys, and others—suddenly have expectations and are
making inquiries. There is increased exposure there. If you don’t know what they would
be asking about, then you should check with internal counsel. Internal audit functions are
notoriously understaffed and unloved. They need you for status within the organization
and to negotiate rivalries. The insurance policy for internal auditing is money well spent.
The problem with internal controls is that it is impossible to be perfect. External audits—
seek out the people below the leader to get a deeper perspective. The only thing that will
keep them independent is for the audit committee to be independent and to empower the
externals the same way as part of normal business practices.
Good management want audit committees to be independent. Establish a respectful
relationship with the staff to be effective. If the staff clams up, you will not get what you
need to done. Have an approach where prudence is key. The idea of independence is
important functionally as well as at a human level. Finally, the employees will expect
prudence and communication.
In audit committee sessions, ask the financial and executive staff to talk to you separately
about what they see as the weak spots. Done purposefully, this can provide an
opportunity for triangulation. Many will be happy to provide insights and suggestions
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that can serve to guide and prod processes. Lay out annual reports to document weak
spots and what is being done about them.
All line management needs to be informed that if they ding someone significantly, that
will go up and down the Sarbanes-Oxley chain of whistleblowing. Talk to HR about this
as well. What seldom gets covered at the audit committee level is how sub-certification
takes place. Many employees have a fear about questions that they might be asked at the
sub-certification level. Ask questions about this and be vigilant. Have a sidebar
conversation with your compensation committee to ensure that they are independent. Go
back to ask, between chairs, if the compensation committee has done their job and
reviewed contracts and agreements.
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GAAP—Accounting and Internationalization
Panel moderated by Colleen Cunningham, Resources Global
Professionals
Colleen Cunningham, Managing Director, Tri-State at Resources Global Professionals
moderated a discussion of current and upcoming changes resulting from the use of
International Financial Reporting Standards as published by the International Accounting
Standards Board operating out of London. The IFRS is principles/deductively based
rather than rules based (e.g., the US form of reporting). Cunningham provided an
overview of the history leading up to the adoption of the IFRS in the US, indicating that it
is now a question of when rather than if. Along with the shift comes a significant training
exercise as schools and professionals need revised programs and education, while open
communication with all stakeholders is going to remain important.
Jim Campbell, Vice President of Finance and Enterprise Services and Corporate
Controller for Intel Corporation, identified several key points and challenges to adopting
IFRS globally:
•
•
•
•
The challenge of wide spread adoption
Understanding that one size does not fit all when adopting
The need to plan for mental change in relating to reporting
The importance of building expertise and codifying processes
All countries will not be adopting at the same rate. India is an example of a country that
will continue to be different and where there will be significant differences for some time
to come. IFRS means a new reporting focus. Companies will need to revise internal
policies and to codify these for uniformity across entities. For economies of scale it is
important to have one framework even when operating at multiple locations. For US
issuers, adopting IFRS will means a material effect on financial presentations.
Campbell noted that is important to recognize that there are only 41 IFRS standards of
which most are still deliberated. It is therefore a high principle based application, yet the
IFRS has a long history since 1975 that is leading to current broad based adoption. The
trend started with the European Union’s 2002 requirement that IFRS be implemented
starting in 2005.
The status process for large MNCs is to:
•
•
•
•
Focus on statutory
Inventory, assess, determine and codify
Build expertise
Begin to think in parallel by following current accounting protocol and also IFRS
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•
•
•
Assess strategic value by considering access and competitiveness under IFRS
Consider the consolidated impact
Facilitate and, importantly, formulate a transition road map
In general, it will take 5 or more years for companies to transition and adopt IFRS.
Between 2005 and 2013, it is important to:
• Lock down an agenda and form of final standards
• Recognize that a transition framework is critical
• Understand that consistent global application is uncertain
• Overcome a rules-based culture
Campbell recognized that you will lose some comparability. The key is to recognize that
for comparable financials, one year is not going to be enough, so several need to be in
place. To change a system is not easy, so recognize that change will take time by
counting backwards. If system adaptation needs to take place in 2010, 2009 will be the
year to determine IFRS, accounting policies, and so on.
There are key areas of divergence, of which the most significant include:
• Consolidation policy
• Hyperinflation
• Impairment
• Provisionism
• Intangible assets
• Intellectual property
• Agriculture
Large companies need to start thinking ahead. Look at key areas and consider the impact
on the corporate system. Know the framework of judgment and the level that will be
impacted, including the opening balance sheet. In addition, recognize that behavioral
change needed is going to be profound. A harmonized approach is going to be critical by
considering what handles well in practice. Ideas that result in superimposed rules will not
be helpful. Instead, start educating various stakeholders, because the IFRS will be a
monumental undertaking with considerable material effects.
Bob Herz, Chairman of the Financial Accounting Standards Board, joined the panel via
satellite to note that the change is market driven by Mergers and Acquisitions commerce
around the world. The change is confusing for investors as well, but Pax Americana is
not what the rest of the world will move toward and different accounting languages
become costly. The IFRS is international, and international includes the US. Herz was an
original member of the IASB and felt that it was important to work together to produce
common standards by working to align agendas. It is important to note that the IFRS
represents a major improvement. It is also a labor of love, constructed by 14 members
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from different parts of the world.
The IFRS does not enter into different developed industry standards. The standards are
fairly broad and different nations will be adapting them to local standards through broad
interpretations. There will be problems, but these will be different problems than adapting
to 100 standards around the world. Some of the challenges include:
• Different starting points
• Differences in industry, business, cultural, and economic environments
• The possibility of misaligned agendas
• Getting Boards to agree or resolve differences
• Resistance to change
• Politics
• US demands for special industry standards and detailed guidance
• Funding, staffing, and governance of IASB
• Inconsistent application of IFRS
The IFRS was needed to mitigate differences and increase similarities to create
consistency across the world. The infrastructures and funding had to become standard
internationally. The US needs to decide a path to move forward, which needs to lead to
an approved outcome. That path will probably be determined in the next year or so.
Herz is not in favor of an extended period of optionality to have either system. There
needs to be a blueprint for the US in the form of a national plan. There is also a need for
education, training, and a changed CPA exam, and LIFO needs to be the same for both
book and reporting in the US. Additionally, there will be questions to address, such as the
new reporting system that is about to be implemented by the FCC, how does that relate?
What are the roles of FASB and SEC? There is definitely pain involved, but the benefit is
at the other end. Above all, the transfer needs to be considered as a major implementation
project, that needs to be well planned and resourced, provided with appropriate oversight
from Boards, governance, and senior management, and followed with timely internal and
external communication.
Liza McAndrew Moberg of the Securities & Exchange Commission pointed out that
what feels new to many in the US has been going on internationally for 20 years. The
IFRS is already here whether we move in that direction or not. Foreign companies
operating in the US will only provide IFRS information and foreign holdings are part of
many people’s personal portfolios.
It is important to have a seat and be part of the discussion. SEC and its members will
monitor and participate in working committees at the International Organization of
Securities Comissions (IOSCO) where information sharing among regulators take place.
SEC has held bilateral agreements with other countries for a long time (e.g., United
Kingdom, Japan, South Korea, European Union) and will continue to be active.
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Governance Committee: The Board Committee at a Crossroad
Panel moderated by Chris Mitchell, Special Value Opportunities
Fund LLC, First Chicago Bancorp and Reis, Inc.
Chris Mitchell, director of Special Value Opportunities Fund LLC, First Chicago
Bancorp, and Reis, Inc., led an interactive discussion focusing on governance, which
finds itself at a new crossroads that includes a broadening of scope and importance.
Participants in the discussion were Bob Rollo, Senior Partner in the Board and CEO
Practice of Heidrick & Struggles, Linda Fayne Levinson, Board Member of NCR
Corporation, Jacobs Engineering Group, Ingram Micro, Western Union and DemandTec,
and John Cardis, Board Member of Edwards Lifesciences, Avery Dennison, and Energy
East Corporation.
Mitchell raised the first question regarding the implications, trends, and best practices
given the current situation as well as what being the conscience of the board means.
Levinson felt that it means to ensure, to step back and take in the principles. The role of
the board is to go back to the basic documents, the Code of Conduct and the Code of
Ethics to ascertain that behaviors are in alignment with what we believe and to make sure
that it reflects that belief accurately. The role of the Board is to reflect on whether we
behave as we say that we should. Rollo continued by suggesting that the Board is a
teaming effort of doing good governance by following good practices and
interrelationships between activities. Vigilance is good governance.
The question continued regarding the role of the Board vs. Governance. Levinson felt
that there are always going to be bad apples on the extremes. Business performance
depends on the right CEO strategy, people and the market. The Governance Committee
needs to nominate good directors, but good governance is not the whole story. Rollo felt
that the Governance Committee has two responsibilities:
• To determine who sits on what committee, turns, and process, and
• Succession planning
The Chairman and the CEO must be involved in the process. The second meeting should
always be with the CEO so that it is clear how the support can be in place. Most Board
members are very sincere about their ability to support a CEO. Levinson noted that was a
major change since it used to be that committee chairmanships were selected by tenure,
but now that there is more interplay and the ability to switch committees there is an
opportunity to reduce vested interests. More respectful and robust discussions have led to
stronger committees with fewer overlays. Cardis pointed out that good governance is
about deep vigilance, what you pay attention to. It is important for committee members to
find time away for cocktails and lunch to get time to talk about what needs to be paid
attention to. Private conversations like that affect governance positively.
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Levinson talked about building Boards from scratch, that it is important to look at skill
sets and general business judgment. Chemistry and good judgment are almost more
important than a neat matrix. Good communication and problem solving skills are key
and go beyond purely skills based models. Rollo recognized that the last Board at
Southern California Edison were all seniors level with multiple skills in each Board
member. Now the Board is more vertical where different individuals have certain skill
sets that others rely on. The universe of potential candidates is getting smaller. It is hard
to find horizontals. Finding key potential candidates to fill the gap means having to
broaden the search when a seat is coming up, rather than replicate the past to see where
the company is going in the near future. Cardis added that it is important to think about
the current Board, to see who could step in to run the company as a natural step in if
needed to fill the void of CEO. The next search should be for that person.
Rollo noted that the Lead Director, in addition to the President, is becoming more
important. Levinson felt that evaluations need to be effective and that it is useful to have
everyone involved in a conversation about what is working and what is not. Cardis said
that the executive session needs to pay attention to the functioning of the Lead Director
and executive sessions, to focus on macro substantial issues and behavior. Levinson
suggested that not only the committee but the staffs of the members need to be included.
The emphasis has to be on talent management and development and evaluation. Rollo
said that there must be an active agenda and tone for evaluations, how these are done, and
the frequency of them. Levinson felt that it was up to the governance committee together
with the Board to set the tone to not just see the CEO but others as well. The CEO is the
Board’s primary responsibility. A possibility is to ask the CEO to write a letter to the
Board at the beginning of the year with goals that need to be accomplished. At the end of
the year the CEO writes a self-evaluation and a new cycle can begin. Talent management
means that the CEO needs to review important people in either the Board or Committee.
Cardis noted that with regard to talent management, Fortune 500 companies are looking
more internally than externally. The focus is on a state of readiness and a need for
grooming A players, which needs to be part of an ongoing conversation.
Levinson observed surprise at how institutionally investors have ceded so much to
ratings institutes. This can lead to conflict when there is a habit of changing the ratings ad
subsequently actions every year just because the ratings committee wants it to be so. That
is foolhardy; the focus needs to be on the longer term. Cardis felt that some statistical
information may be important, but not to be evaluating continuously. Levinson noted that
it is important to be respectful of shareholders, and to communicate with them.
Mitchell pointed out that individual director evaluations on a peer to peer basis may be
unsuccessful. One-on-ones may be more successful than tabulated forms. Forms may be
good as a starting point to identify shortage of talent, but the real value lies in
interviewing one on one. Levinson said that everyone knows when someone doesn’t
show up and the Lead Director will talk with that person. There is a retirement age
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discussion in some boards, but some good directors are also lost. Where the retirement
age has been eliminated, members make a pact to be vigilant not only when it comes to
age with an eye toward not nominating someone again that does not perform. The
Governance Committee has to not renominate and instead gracefully ask them to leave.
Rollo observed that not everyone leaves gracefully and that some resort to writing letters
to shareholders who need explanations. Cardis added that the ISS dropped the age
requirement with the argument that age is not the same as competence.
Levinson noted that there needs to be a line between the Board and operations. A Board
of all active CEOs is dreadful because all want to be in charge. There is a need for others
to mitigate. Further, when a CEO has a hard time the active CEOs have the hardest time
to act because they empathize. Cardis felt that Board members must bring real tangible
skills to the Board. It is important to bring in global talent to the Board. That does not
necessarily mean non-US members, but definitely overseas experience. Board members
must also know the company’s customer base, industry and where it is heading. Rollo
finally noted that people may shy away from short term appointments of a year or less.
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Keynote: Myths and Misconceptions about Boards
Paul Haaga, Director and EVP, The Capital Group
Paul Haaga, Vice Chairman of Capital Research and Management Company and
CRMC’s Executive Committee, identified several myths and misconceptions about
Boards:
• The Board’s only role is to hire and fire CEOs—a myth perpetuated by CEOs
who want the Board to stop meddling. The reality is that all CEOs stay too long.
They don’t become bad, but eventually the sitting CEO is no longer the right
person lead because they have run out of ideas and energy. It is hard to figure out
when to move them along.
• The Board’s only role is to police conflicts of interest—this is not entirely untrue,
but definitely overstated. There is a sense that everything of interest or concern to
the Board is filled with conflicts of interest. It is important to know what conflicts
and interests are aligned instead of attempting to set up a tug of war.
• Board members should have specific skill sets that line up with departments and
the practices of the Board—rather, Board Members may come with
predispositions or assumptions that need to be unlearned because they “know”
things that are not true. Boards, as a rule, should be working Boards.
• Lawyers should tell the Board of their duties—in reality, they just need to know
the general parameters.
• Board effectiveness should be measured by X—whatever X means (rising stock
prices, CEO firings, rejected proposals). The problem is that being measurable
doesn’t mean important.
• Independence is the most important characteristic of outside members and
Directors—independence is a part of what is needed, but it is important to be
wary of overemphasizing independence at the expense of effectiveness.
• Governance committees serve as the consciousness of the Board—the idea that
“someone might be watching” is rather a matter of conscientiousness, that is, a
Board that is asking the right questions.
• Sarbanes Oxley makes better Boards—rather, Sarbanes Oxley raised the worst
Boards to a level of mediocrity. Certification may take something away from
judgment. The question is what certification really means. The system is getting
better but there is a knee jerk reaction in place that says that when something goes
wrong, all we need are better rules.
Form and appearance do matter. The Chairman of the Board rather than the CEO should
be the one to inform. Actions and appearances go hand in hand. When Enron kept
flashing stock tickers in the hallways, it kept the focus away from long range planning by
emphasizing short-term immediacy.
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Executive sessions are good because it is possible to say things that cannot be said
somewhere else. That is the time to identify issues to be addressed later, but not to
immediately resolve them. The question is also whether to use committees or full Boards.
Committees are important, but it is important to watch so that they don’t take over the
role of the Board. Similarly, evaluations are important, but as a form of asking how we
can do better rather than as a “grade.” Evaluations are often unnecessarily painful with
too much of a focus on the negative.
Boards should also be concerned with pay and how compensation is paid rather than what
is paid. Fixed income funds—that is, measuring point-to-point total return—means not
paying them for stability. Further, CEO income generation lines up better with
expectations when tied to income generation, for example, to the stock market. Shortterm vs. long-term analyses are needed, but long-term can be overdone and the reality of
long-term as a series of short-term blocks forgotten. The principles of governance
therefore mean recognizing that both are important.
Attorneys do not have to be there when the Board meets. There may be times when the
members will want some discussions without the attorney present. When the attorney is
around, some things will become privileged that otherwise would not be.
Overwhelmingly people involved are good people. Sometimes motivations and stock
prices get them a few degrees off the mark, for example, when structural changes provide
challenges. Outside directors have been important when it comes to asking for advice.
They can often provide faster, better solutions because of their outside perspective. It also
is important to spend a lot of time on succession planning. Bring up and comers to Board
meetings to provide onboarding experiences.
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Role of Private Equity
Panel moderated by Duke Bristow, USC Marshall School of
Business
Duke Bristow, Associate Professor of Clinical Finance and Business Economics at the
USC Marshall School of Business, moderated a panel discussion on the impact of private
equity in business.
Jim Williams, Partner of TPG Capital, talked about the relationship between private
equity firms and management as a reporting vs. participative relationship. The latter,
where management is talking with the equity firms, is the best form of conversation.
Situations where the CEO functions as a gatekeeper for all forms of communication does
not work. Private equity holders need to be able to talk to the “passengers” on the bus as
well as the “driver.”
There is an adage that says that the more general counsel speaks in a Board meeting, the
less effective the meeting is. Board meetings need to focus on interactive conversations
rather than repeating information that has already been received and read by participants.
Too often CEOs try to domesticate their Boards, as though turning a tiger into a kitten,
but by doing so the effectiveness of the Board is limited.
Every new deal provides a fresh strategic view of the business to understand core
imperatives from a fresh perspective. Quarterly meetings allow Boards to go in depth
with strategies of the business, whereas the monthly meetings tend to focus on
operationals. Boards need to engage in questioning. The most important task for the
Board is to engage in selection of the CEO and then to follow up with monitoring and
coaching. Talent management is the key.
Much of the Board’s work is done outside Board meetings through dialogues with the
CEO and other members throughout the year as well as by interacting with the business
itself. For example, if the business operates in the retail industry, then members need to
actually go to the stores to experience these first hand. The relationship between the
Board and the Executive Team goes beyond the CEO but the emphasis has to be on
supporting the CEO to succeed.
Simon Lorne, vice chairman and Chief Legal Officer of Millennium Management LLC,
felt that people’s views are impacted by their economic self-interest. Activists are there
because there are legal issues. Activism comes about when there is cause to worry about
antitrust, a slight perversion of laws that worry about what we do. Antitrust ask us if the
swap is kosher, a regulatory scope creep, or if ownership is hidden. The legal system has
not yet figured it all out, so activists take on an important role. The vilification of Hedge
Funds is a sign of defensiveness. The Williams Act focused on institutional ownership in
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response to partial takeover activity. Lorne indicated an approval of the activist role
because activists encourage Boards to take appropriate actions. There is improved
corporate governance when an activist threat is imposed. Hedge Funds and activist
shareholders improve the situation for all shareholders.
The separation between voting and economic interests is problematic. It is impossible to
tell if mergers received the votes that were needed, because by sending proxies people
may vote for shares that they are not eligible to vote for.
Bristow raised the question of whether private equity is dead given recent events, to
which Williams responded that private equity is here to stay even though some large
deals will hit a bubble. It’s an aggregate that forms 2-5% of the overall economy. When
credit eases up in 6-18 months, there will be a cyclical recovery that is part of a natural
correction. Lorne noted that it’s a problem of extraordinary growth and the prospect of
fast money. Banks are looking at 5 week; it is human nature to not think about 15 years
down the line when they are concerned with 5 weeks in the short-term. Williams also
suggested that there is xenophobia when it comes to equity from overseas investors (e.g.,
the buy-out of IMBs PCs by China), but it is important to realize that they are investing
because they want returns, not for political reasons. Public boards should have regular
discussions that include the infusion of public equity. Private equity should be interested
in retaining CEOs as part of a private company, but there can be bizarre conflicts in goforward deals so it is important to include one-on-one Board member discussions. Lorne
emphasized that the conversations have to start with the CEO.
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Compensation Committee
Panel moderated by Kevin Murphy, USC Marshall School of
Business
Kevin Murphy, the Kenneth L. Trefftzs Chair in Finance in the department of Finance
and Business Economics at the USC Marshall School of Business, led a panel discussion
on the explosion in CEO pay that Murphy presented as driven by grants in restrictive
stock. Such compensation more than tripled between 1992 and 2006 to a point where
stock equaled or surpassed options. The challenge is also that compensation consultant
companies that are urging for increased pay, leading to questions of conflict of interest
since there are incentives to inflate pay to influence the chance of getting engagements by
the consultants. Some compensation consultants are finding that companies that are
shopping around until they get the answers that they want or like. Additional current
events that compensation committees are faced with include the Option Backdating
Scandal, the Use and Abuse of Severance Agreements, and a question of whether there
needs to be a form of Sarbanes Oxley equivalence for compensation committees.
George Paulin, Chairman and CEO of Frederick W. Cook & Co., Inc., addressed the
issue of compensation consultants by noting that Sarbanes Oaxley in 2002 represented a
vast improvement in compensation committees, which are now more proactive and
independent as a rule. The overwhelming majority of them are fair. CEOs are aggressive
about their compensation. The compensation committee wants to support them and then
to move on to the next one and is therefore less likely to push back when there is an issue.
Paulin noted that there are several challenges facing compensation committees:
• Questions of performance measurements tied to compensation. Compensation that
is over-designed as can happen with variable pay plus goal driven compensation.
Goals are the key to successful programs.
• Long-term incentives. Five years ago compensation was 85% in stock options,
now that is down to 45%--a big change. Options are converted into time restricted
stock, but can be challenged when too much compensation is in stock that is
going down with not enough stock going up. Some companies are moving toward
time based restricted stock.
• What is coming next? Another Sarbane-Oxley? Proxy statements were 40%
longer last year than the year before which means that they consist of too much
data that is not comparable from company to company.
Summary compensation tables can be misleading, because they are accounting
accrual of all equity compensation plans but have nothing to do with compensation
granted that way. Pay for performance that does not match up with the numbers in the
table is a problem. There is legislature on executive compensation coming up.
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Coupled with a mandated majority, voters will have an effect on compensation.
Shareholders will go after non-direct compensation, such as severance, perks, and
supplemental retirement. There is an indirect push back to keep direct compensation.
Companies are pulling back on the perks and supplemental retirement.
Anthony Chidoni, noted that looking at compensation as a measurement of
performance provided a numerical sound rod. Compensation should be a reasonable
assessment of what makes sense. The picture may in time become misleading, but
you can never go wrong by following the cash.
It is important to measure CEOs in relation to what they have said as a benchmark.
There has to be a financial base for measuring the performance of a CEO. Free cash
flow is the lifeblood of the company, so if it is not measured there needs to be a
discussion. To look at the stock price alone is a mistake. People must be held
accountable to their vision by looking at objective items, income, and the balance
statement. Proper judgment must be used to reflect on what they said that they would
do and look at challenges for the year. Ask the question, what value added do people
running the company bring?
A discussion followed that included a focus on whether the relative total shareholder
returns could be used as a performance measure. Paulin suggested that it can be used
to show relative value compensation disclosure but not as a base for performance. It
is a measure against the industry if it has strategic validity. While improvement takes
place and it is valid, it also tends to have a binary effect while measuring point-topoint. When measuring compensation, the macro environment must be taken into
consideration.
Paulin felt that best practices in terms of qualitative metrics means taking into
account unplanned events and progress that may be hard to measure. Quantitative
measures are needed to know how much. Chidoni noted that it is important that data
not be too generalized and that even qualitative metrics must have rational
explanations. Paulin observed that there is no such thing as one size fits all.
Performance metrics have to address different goals and to attract, retain and direct
toward different outcomes. Murphy wondered whether qualitative measures are more
difficult to convey to shareholders. Paulin pointed out that goals are always set and
measured, even though the total compensation is hard to see. Chidoni felt that
decision makers are looking at qualitative metrics as a way to measure performance.
Murphy stated that inflated packages often come from previous positions. Paulin
said that since Sarbanes Oxley it has become preferably to grow your own CEO
rather than develop internal candidates because internal grooming is often considered
the failing of the Board if someone is not found internally. Chidoni recognized the
rock star status of CEOs, which is also driving up compensation.
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The Risk Intelligent Board
Panel moderated by Les Sussman, Resources Global Professionals
Les Sussman, Managing Director of the Resources Audit Solutions unit of Resources
Global Professionals, moderated a discussion on risk management by asking the question,
Where do you draw the line between what the Boards should be doing and what the
management should be doing in the risk management arena?
Rick Funston, Principal and National Practice Leader for Deloitte & Touche LLP’s
Governance and Risk Oversight services, pointed out that most people miss the gorilla in
the middle of the room when focusing on the task, recognizing that when you are not
looking for something, you will not find it. Between 1975 and 1995 there were 112
systemic banking crises according to the IMF. Now that we are in a credit bust, that is
interesting. We are in unchartered waters—companies are not too big to fail, but very
interconnected not to feel the turbulence. Companies are suddenly experiencing huge
losses, uncertainty, randomness, irrationality, high speed, and more commotion. The
challenges are significant.
The Board’s role is to assure reasonable people are managing the company, and to
ascertain independently that that the risks are minimized. Capitalism means that
companies make money by taking risks. Certain risks have potential for reward. Longterm analyses have to look at risk and reward through a lens of enterprise management:
how to take what you have and create new value while managing and meeting
expectations. Companies need to look at what it would look like if they failed, and how,
to retain customers and recruit additional ones. Generally, the responses fall into any one
of the following categories: people, process, systems, facilities, and external factors. The
growing recognition is the importance of a systemic approach to risk management.
Modern approaches to risk management has failed because the misuse of derivatives.
There are several flaws in risk management today, including:
• Situational awareness
• The ability to imagine failure
• Relying on models that fail to take turbulence into consideration
• Failure to corroborate data
• Failure to consider speed – bad things happen faster than good things do
• Failure to maintain a safety margin with the critical dependencies of the company
and how long you can go without them
• Short-termism
• Complexity
• Misuse and abuse of derivatives
• Failure to take enough right, calculated risks
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It is necessary to take risks, you just need to know what risk you are taking. Effective risk
management takes this into consideration. Risks need to be part of enterprise
management (EM, not ERM), and it needs to be managed at the extreme points where it
matters most. Risk management means relying on a systematic process. The trouble is
usually known beforehand, but the institutional ability to raise fear is not well
established. It is good to establish accountability so that you know who is responsible,
including owners and operators. Finally, risk management should be tied to the cadence
of how the business runs itself.
Bruce Meikle, Chief Compliance Officer and Chair of Audit Committee at The Capital
Group Companies, noted that sophistication of risk management rose during the same
time period that Rick discussed, yet got lost in the organization. Three areas are
particularly important to focus on: modeling, short-termism, corroboration.
• Models often focus on numeric, financial data is presented that is often taken for
granted without questioning the judgment behind it. Nobody pays attention to the
fundamentals. It is important to pay attention to the lessons learned from other
companies. Often there are policies that have not been enforced, including how
management follows them, thereby creating a sense of entitlement and lack of
action at lower levels.
• Short-termism includes the subtle messages that incentivize people to pay
attention to what it is that they are rewarded for. Part of the role in the risk
management side is not getting too far away from alignment with where the
company needs to go long-term and those objectives.
• The failure to corroborate is as much a failure to fully discuss issues and
underlying problems. It is necessary to move away from a model approach to a
discussion approach to try to reach corroboration and look at what approaches and
communication need to occur within the organization.
It’s not a matter of coming in to discuss how to manage risk, but how business is
managed and how the tone is set as well as how subordinates and associates are
operating. Encourage Directors to have more direct connections with associates and
subordinates.
Richard Slater, Strategic Advisor to CEO’s and Boards of Directors, pointed out that
businesses are financial institutions that need to manage both internal and external risks.
The question is how to take risk and turn it into profit. Slater described breaking away
from Halliburton, by setting a template, taking that formula throughout the organization,
and recognizing that internal risk management is a matter of focusing on the DNA of the
company. There must be internal checks and balances, including the line management
function, to provide oversight. Important is to look at the use of foreign partners and
agents, while also overseeing and independently judging the status of projects. Special
Board meetings take place focusing specifically on risk projects so that all Board
members continue to be briefed, as well as updates on the status of the projects.
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On the sophisticated side there is a lot of analysis. Despite the probability analyses,
disaster will happen outside the calculations, so it is important to look at risk probability
and possibility, and to never take on projects with extraordinary risk.
Having a special committee is important, because employees should never be put in
harms way including when on assignments in Iraq. Foreign companies are not as used to
using the tools, so the use of hotlines when there is a discrepancy has been helpful. A
legacy issue remains with the Department of Justice. The Board is not there to secondguess management, but to serve as a sanity check. Once signed up on it, everyone has to
be on board. Members of the Board discuss what is considered to be acceptable risk and
what is not, including countries and businesses to partner with. It takes time to work
through contract administration, especially with KPRs legacy from Cheney and
Halliburton, which may be repeatedly presented in the activist press.
The follow-up discussion focused in part on derivatives and the complex nature of
derivatives historically. From a risk management perspective, derivatives need to be
understood in a broader market.
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Activist Argument Toward Boardroom and Directors
Panel moderated by Ed Merino, Office of the Chairman
Ed Merino, Chief Executive Officer and Founder of Office of the Chairman, moderated
a panel on the role of activists in governance by stating that effective communication is
most important. Both sides need to be more engaged to seek rebalancing, which is
assisted by voluntary best practices reforms. Boards need to be open to shareholder
communication and to avoid needless confrontation.
Richard Bennett, Chief Executive Officer of The Corporate Library, LLC, said that
shareholders decide to take action regarding issues such as executive compensation and
racial or gender equity. Activism has a long tradition leading back 75 years. One way of
engaging as an activists is to sell shares as a simple way to send a message, but the
problem arises when organizations such as TIAA-CREF and others cannot escape the
market.
There are several factors leading to the rise in stockholder activism, including:
• The rise of institutional investments from 7.2% of US equities in 1980 to 63.4%
in 2004, of which pension funds account for 1/3.
• A change in FCC rule 1488, shareholder proposal rule, whereby principal
shareholders and management acts underlying securities law allowed activist
shareholders to engage topics, including global warming, governance, and the
makeup of the Board.
• The 1980s overall focus shift to corporate governance.
• ERISA (Employment Retirement Income Security Act) of the mid-1970s, which
meant that pension plans would solely benefit the participants evidenced by an
amplified Avon letter that resulted in the development of ISS (Institutional
Shareholder Services).
• The SEC changed proxy rules in 1982, which were narrowed to solicitation so
that information and concerns could be shared.
• Emergence of relationship investing
• Corporate scandals leading to Sarbanes Oaxley
• Mutual fund vote disclosures per 2004, requiring disclosure of how shares are
voted
• Rise of Hedge Funds
These nine events overlap and mutually reinforce increased shareholder activism, which
like death and taxes will not go away.
Stephen Brown, Director of Corporate Governance for Teachers Insurance and Annuity
Association of America—Colleges Retirement Equities Fund (TIAA-CREF), noted that
shareholder activism started the interest of looking at corporate governance. TIAA-CREF
owns about 10% of corporate America and is looking for sound governance that will
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yield long-term results. To that end, the desire is to engage with companies through quiet
diplomacy that will allow the companies to take the credit while returning rewards to
shareholders.
Activism starts with an issue, not necessarily a company, at the macro level warranting a
qualitative and quantitative analysis to focus the issue itself. TIAA-CREF will pick the
top 10-20 companies and start the engagement. Activists protect shareholder rights by
giving deference to the Board and management. As an owner, it is important to make sure
that the Board does its job. Large institutional investors such as TIAA-CREF have
resources and a duty to exercise the right as owner. To enact the TIAA-CREF mission
correctly and to get its constituents through to retirement, it is important to focus on the
economy and value of a company.
Ashwin Rangan, Chief Information Technology Officer with Marketshare Partners,
LLC, observed that interested stakeholders are not necessarily shareholders. Using the
example of Walmart.com, Rangan discussed pairing technology that compares purchases
with what similar others also purchase. Technology makes it fast, but when it misfires by
misaligning two promotions for the psychographics of one customer, it only takes 30
minutes for the blogosphere to register a presumption of liability. That leads to two key
observations:
• Technology has become a megaphone to discredit a brand. The blare of the
megaphone drowns out the voice of reason, so consumers react rather than think
through the situation. That is what activists are trying to do when they try to
drown out rationality. The philosophy of operations has to be that there are
aberrations that can be explained.
• Technological means of communication are at work and provide an opportunity to
leverage. Activists embrace technology. Brand stewards need to become more
educated on how to use it, like Google’s daily blogs. The lesson is to not let
technology become a barrier but anticipate the need for a rapid response.
Richard Slater, Strategic Advisor to the CEOs and Boards of Directors of publiclytraded companies in the US and Europe, drew a comparison to social and environmental
activism. In the UK, Sweden, Netherlands, and Australia, among others, policies have
been adopted that include environmental policies on the sale of shares and the
corporation’s part in social responsibility. Governance practices have to be revised and
adapted, along with computational policies that have an eye toward the best practices for
the company, but are ultimately aligned to include CEO pay and valuation of
shareholders stock. That is not an easy target for unfriendly activism and other
opportunities. In addition, Hedge Fund activism has meant that long-term shareholders
have become pretty vocal.
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USC Marshall School of Business
2008 Corporate Governance Summit
Event Summaries
It is important to have a growth plan for the future that includes the shareholders. Hedge
Fund shareholders are interested in short-term cash, so it is important to communicate
with them. Institutional shareholders seem to be supportive of this approach as well.
The panelists recognized the need to work together and to recognize that integrated
governance works. Proxy season is here and proxy issues will not go away.
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