Governance HW

Fortune (July 1 2002) Restore Confidence With Reforms

1-trust and verification - state earnings and profits in a meaningful, simple, standard way subject to reliable audit, less to manipulation; 2-support the SEC – staff too small to watch 17000 public companies, multitude of mutual funds and brokerages, the exchanges, market manipulations, insider trading, accounting transgressions, all suspicious behavior, and a market covering roughly $12 trillion.

– staff is paid 25%-40% less than staff of the FDIC or Office of Controller – turnover is 30% versus the 15% at other U.S. Government positions – vacancy rate is twice that at other government agencies – SEC has collected $2 billion in fees in a given year, 5x its budget – Congress uses $$ elsewhere; LOC staff has grown 4x faster than SEC.

Reforms 3-regulate Chair/CEO compensation. Consider the following examples of CEO earnings from the first half of the first decade of this current century for those leading their firms just prior to the firm declaring bankruptcy or the individual being charged with misappropriation of funds. • Person Firm Compensation Event Year[Bankruptcy or Charges] • Jeff Skilling Enron $240 million 2001 • Gary Winnick Global Crossing $735 million (3 years) 2002 • Dennis Kozlowski Tyco $240 million 2004 • Joe Nacchio Quest $232 million 2005

CEO compensation • Although it may now be more closely linked to firm performance • Amount is grossly out of sync with normal merit reward. • Institute for Policy Studies reports to match the increase in CEO compensation over 20 years and to maintain the ratio between worker salaries and CEO compensation

– average productive worker in the U.S. would need to earn $120,500 annually – minimum wage should be $25.50. In contrast, current minimum wage in the US is $7.25 per hour, with Wal-Mart paying $8.23 on average per hour and $22.41 as the average per hour wage in the U.S. labor market.

• CEO compensation in 1980 was 40 times the average employee salary; by 2000, CEO compensation was 600 times average worker salaries.

Reforms 5-improve the Board – increase both the number and independence of the independent members, require education and training, and remove the CEO as Chair of the Board.[1]

(Duality: common in US, restricted by GB) 6-involve Owners- empower the owners: the stockholders.

Consider: Board members receive special benefits, top executives receive “perks’ such that Stockholder Value Maximization is not the primary concern. Individual compensation is a combination of stock value plus perks (plus salary & compensation): willing to receive these at other stockholders expense

• [1] http://www.directorship.com/separation-anxiety/. • [2] Disney

– separate audit and compensation committees – each with independent directors – outside directors meet separate from insiders and management – outsider directors are restricted on the number of other boards to which they are appointed and still serve on Disney’s

primary keys of responsible governance are undermined:

Consider: - largest portion of NYSE is held by institutional investors - these institutions then represent the individual in the monitoring of the performance - Institutional Investors rely heavily on the management and boards of the firms - Institutional investor may very well feel a reduction in scrutiny is appropriate - result in rubber-stamping - About 7% of institutional investors own 44% of the stock market. - How do they vote, when do they vote, do they vote, do their votes reflect the desires of the stockholders for whom they are the agent? - If the institutions do not report how they vote and/or routinely vote with management, then stockholders are not exercising control. Board unresponsive, Institutions uninvolved, Management irresponsible: Crisis

Robert A.G. Monks a shareholder activist

• CEOs have too much power • Boards of Directors are not minding the store • Corporate Democracy is a myth. • institutional investors routinely vote with management • empower institutional owners

– LENS, a mutual fund that targeted lackluster firms, and then agitated for change • fund’s performance is reported to have outperformed the S&P 500 Index throughout the life of the fund

– 1985, Institutional Shareholder Services (ISS) to sell research and advice concerning Proxy votes. • ISS’s support for the Hewlett-Packarad/Compaq merger led to its completion..

• Activists have impact: – 1942, the Gilbert Brothers encouraged SEC to pass the first rules concerning shareholder proposals. – 1960s, Ralph Nader and Saul Alinsky encouraged individual shareholders to pressure firms on social issues causing significant changes. – 1980s, corporate raiders changed poorly run firms either by taking control or forcing current investors to pay attention!

Questionable Practices • CEO selects Board composition • true dialog among the Board membership due to privacy issues • independent members being allowed to meet in closed session • financials reported with minimum explanation, dialog or discussion • Board routinely rubber stamps the presentations by management • fraudulent accounting practices and poor management decisions • outsiders or independents should not be ex-employees, family members, or anyone whose livelihood derives monetary benefit • under-qualified directors • increasing awareness of Social investing, concentrating on sustainability issues • removing lax standards for audits and for Board membership • use of super majority voting (80%) instead of majority voting (51%).

– Investor Responsibility Research Center reports that in 1990, two-thirds (2/3 or 67%) of shareholder resolutions passed when stockholders voted, but in 2000 only 17% passed due to the restrictive nature of supermajority voting.

2004 CalPers examples of Governance lapses

• Gateway – requires no independent audit. • Quest Communication International – allows for a conflict of interest in dealings • with the Anschutz Corp, since the Quest chair and founder is Phillip Anschutz who is also a director of the Anschutz Corp. • NTL – approved a re-capitalization using a Debt for Equity Swap that, in their • estimation, will negatively impact on stockholders, such as themselves. • Lucent Technology – will not agree or act with the simple majority vote about the • composition of the Board, requiring instead a super majority. • Cincinnati Financial – one half of the Board membership is insiders.