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Skip Navigation LinksHome :: Back Issues :: Who governs the corporates?

March 2002

Who governs the corporates?





       
Bert Denton
It's a common assumption, in the US and abroad, that Americans believe they have the best financial system in the world and that it is the most open, the most progressive, and the best model for others to follow. But consider this statement from an American institutional investor. "You know, I really don't like the Vorstand-style of governance favoured in parts of Europe," he told Euromoney last month. "But maybe it does have some advantages over our system." His beef is simple: "The US CEO has become more and more the fox guarding the hen house," he explains. "And he is enriching himself and his executives in the process. More and more companies are being run for the benefit not of the shareholders but of the people running the firm."
These are two crucial issues: the CEO has become the overly dominant force on the board and his pay structure is part of the problem. The role of chairman has been undermined. "I've been in my fair share of shareholder initiatives," says Bert Denton, founder and president of Providence Capital, a New York-based firm that is a broker-dealer, an adviser to institutional investors and a manager of a small investment fund. "It's a much easier conversation when the chairman and the CEO are two different people. It lends a degree of distance and perspective at the head of the board that you don't get from a CEO-chairman who might be loaded up to the gills with options."
The CEO is supposed to run the firm day to day, and have its managers report to him. The chairman is in charge of running the board and managing any strategic issues that are presented, such as investor discontent and merger and takeover offers. The chairman is also the link between investors and the board. Give CEO and chairman roles to the same person and there is a fundamental conflict of interests. Throwing in a pile of stock options just exacerbates the problem. "The US system gives incentives to top management to shoot the lights out in the short to medium term on earnings," says Denton. "The rewards, based on the value of stock options, are overpowering."
The answer is not simply appointing someone to be the chairman, though. That chairman ought to be independent. That would appear to rule out often used methods of appointing non-CEO chairmen, such as when a CEO retires. Merrill Lynch CEO David Komansky hinted last month that he might step down as CEO before he retires in 2004, but would remain as chairman - how independent is that? Another example from the financial services industry: when Chase and JP Morgan merged, Morgan's CEO Sandy Warner became chairman but most assumed it was just a way of preparing him for retiring, which he announced a year after agreeing to the merger.
On February 4, Sarah Teslik, executive director of the Council of Institutional Investors, an industry body whose members manage nearly $2 trillion of pension assets, sent a letter to Securities&Exchange Commission chief Harvey Pitt and to those congressional committees investigating the Enron debacle.
One of the reasons for the letter, she wrote, was that "the frenzy surrounding the Enron meltdown - while generating voluminous media coverage - may fail to result in any meaningful reforms to a system clearly in need of improvements". Teslik outlines seven steps to improving investor safeguards. Some deal with accounting and auditing issues but three are directly related to corporate governance. First and foremost, the SEC should enforce greater disclosure of business links between board directors and the company itself, as well as with other companies. "Director independence is an issue of fundamental importance to Council members and other investors," reads the letter. "We think it's meaningful to know if a CEO's personal attorney sits on the board or if the director works for a non-profit that receives significant contributions from the company, for example."
Bizarrely, it would appear that current US regulations on a board's composition discourage active appointment of independents. As Teslik writes: "Current standards for board independence are inadequate, with the NYSE only requiring two outside directors and Nasdaq and Amex only requiring a sufficient number of independent directors to satisfy the audit committee requirements." The CII and other institutions, including pension fund Calpers, are looking for boards to be made up of directors of whom a "substantial majority" are independent.
There are two other issues that particularly vex the CII and its unofficial spokesmen such as Denton. The first is Rule 13D of the 1934 Securities Exchange Act. This puts a brake on any investor that holds more than 5% of a company whereby the individual or investment firm with the holding has to declare to the SEC that he or it has no interest in pursuing matters that could lead to a change of ownership or a significant change in strategy for the company.
The second is the poison pill. It was designed in the 1980s to defend against hostile takeovers but is now just as effectively used in warding off major shareholders trying to exert an influence on the company. The CII's stance is clear on poison pills: "Poison pills can and almost always are adopted by boards without shareholder approval. Shareholder resolutions calling on companies to redeem their existing pills and put any future pill up for shareholder vote have been winning majority votes for years, but are usually not implemented by the board."
It's not insurmountable, though. Pension fund TIAA-CREF reports on the corporate governance section of its website that virtually all the US companies it has approached about getting rid of dead-hand poison pill clauses have agreed to do so. A dead-hand poison pill can only be undone by the board that instigated it, or their designated successors.
But corporate governance is not simply about shareholders getting a rough deal. They have to want to change matters. And while some do, there are many that do not. Bank of America Asset Management CIO Mike Kinneally puts forward a typical view: "If you're going to invest in a company, judging management is part of that. It's not our job to second-guess the CEO but in the interests of shareholders we do make sure he is making intelligent judgements." You may well wonder just what the difference between the two approaches is.
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