A most curious press release sprouted up amidst summer’s hot growing season: 13 leaders of public companies and investing firms have put forth self-professed governance principles for public companies. (See www.governanceprinciples.org) As can often happen with a group drawn from diverse constituencies, however, and no matter how laudable the goal, the message avoided controversy – and thus at times clarity. In many areas the principles simply restated what has become commonly accepted as the norm – and in other areas they merely described known facts without clearly adopting a position – thereby resulting in analytical hedging. While the governance principles are undeniably appropriate to initiate a dialogue, they beg the question of what raw issues lurk under the surface.
The leaders were drawn from the heads of:
- Public companies: GM, JP Morgan Chase, GE and Verizon;
- Actively managed funds: Capital Group, Berkshire Hathaway (yes, Mr. Buffett), JP Morgan Asset Management and T. Rowe Price;
- Diversified asset managers (and indexers): Blackrock, State Street Global Advisors & Vanguard;
- Public Investment Arms: Canadian Pension Plan (CPP) Investment Board; and
- The Activists (or the “Constructivists”?): ValueAct Capital.
While the group took pains to note that their cadre was small out of practical necessity – not intent (the deliberations were conducted in secret) – notably absent from the cross-sample were:
- Newer public companies: Google, Apple, Facebook (or even slightly older companies such as HP, Microsoft or Intel) – the issuers were drawn all from respectable and great companies – but ones who come from a very different cultural background than newer, but still large and well capitalized public companies – with many of them on the West Coast and many of them in technology.
- Midcap public companies: Governance has cost. Hearing the duties of a lead director of a large company these days is akin in some respects to having a shadow CEO. Moreover, investment firms have limited resources devoted to governance and a smaller company may find it difficult to find receptive bandwith. Small and midcap companies out of necessity have different approaches and perspectives.
- The largest US pension funds: Yes, the CPP manages $200 billion USD in assets. However, no CalPERS ($300 billion – dwarfing the CPP)? No CalSTRS ($189 billion)? No New York City pension funds (for a New York based group) ($163 billion in assets)? And irrespective of size, each of CalPERS, CalSTRS and the New York City Comptroller have been extremely involved and vocal on governance.
- The “activist” activists: ValueAct is known for pressing management in private and rarely going to a proxy contest – accordingly, their need for the levers of the shareholder franchise may be less pressing that those activists who threaten (to some, perhaps bully and to others, shake up underperforming) management: Carl Icahn (witness the eBay/PayPal split), Nelson Peltz (the subsequent merger of Dow Chemical) and Jeff Smith (the wholesale overthrow of the Darden board).
- The advisors: At the risk of self-promotion, it is interesting that the group lacked any senior presence from those advisory constituencies who regularly must sort out these issues: whether from proxy advisory firms, investment banking or law firms.
This group of ultra-large asset managers and public companies somewhat unsurprisingly focused on general contours of evolutionary governance – no matter that many, if not most, of those contours are widely accepted norms already, particularly by the primary proxy advisory firms (ISS and Glass Lewis).
The group’s overarching themes include:
- Executive sessions without the CEO and meeting management below the CEO level;
- Benefits of board diversity;
- Either an independent chairman or a strong lead independent director if the position of CEO/Chairman is combined;
The Stockholder Franchise
- Majority voting: a majority of votes cast “for” a director must exceed the number of votes cast against, with broker non-votes and abstentions not counted;
- Dual stock structures are not ‘best practice’ and should have sunset provisions ;
- Written consents and special meetings “can be” important mechanisms;
- Optionality of providing earnings guidance;
- Including GAAP results prominently – and not excluding stock compensation expense for non-GAAP measures;
- Access to institutional investor decision makers; and
- Asset managers should devote appropriate time to analyzing votes.
The interesting and perhaps most controversial part of the group’s principles is within financial reporting. Providing guidance – particularly short term guidance on multiple variables – is increasingly being scaled back by companies – and large asset managers (as opposed to the ravenous appetites of the sell-side analyst community) may find such guidance not terribly useful for fundamental analysis. The role of non-GAAP reporting is also under scrutiny: The SEC has recently experienced renewed vigor in scrubbing non-GAAP financial provisions. It is interesting to note, however, that while the group clearly is advocating that stock expense cannot be part of a non-GAAP rubric, the group itself excludes companies (traditionally in the technology space) where equity customarily has been non-GAAP’d out.
The guidance offered is a good beginning of what should be discussed. Yet, here is what is also needed:
- Clarion positions that stake out firm ground in controversial areas: For example, take this less-than-fiery statement from the principles: “Directors should be business savvy, be shareholder oriented and have a genuine passion for their company.” Granted, board members draw from academia or government may not be as “business savvy” as one would hope – but generally such directors have unique depth in a given area and are balanced by other members.
- Drilling down on the prior point, in a staid recitation of the past couple of years’ evolution on proxy access, the group dissected where proxy access has gone – but failed to endorse proxy access explicitly, any specific provisions or advocate for more or less access.
- The group did a similar recitation that some companies have board age limits and some don’t. And the group called for companies to articulate their positions and explain any exceptions. Communication. But is 70 the ‘new 68’ – or 72 the ‘new 70’ – What is the position of this country’s leading investment funds on age limits and whether or not they truly make sense?
- Addressing “short termism” vs. “entrenchment” and the right balance – or the risks of short-termism (such as leveraging up a balance sheet to return a special dividend potentially to the detriment of long term R&D and the business over decades, not a single one time hit of capital return). Or the role of sharply divergent viewpoints often presented by activists and how such viewpoints actually may inject fresh intellectual capital onto boards – or whether classified boards impede short termism or merely are entrenchment mechanisms – and what the standard is for accepting or rejecting them.
- The role of plaintiffs firms and litigation both good and bad – including the extent and wisdom of exclusive forum limits and even fee-shifting provisions.
- Stark and raw self-inspection of the actual underpinnings of modern boards: The dean of the American corporate bar, Marty Lipton, has bemoaned the current paradigm of governance: Boards composed of almost exclusively of outside directors, save for the CEO – it is increasingly rare for a board to have more than the CEO as an inside member. Such (mostly retired) board members oftentimes spend no more than 8 (perhaps 10-12 at most) days per year in a regular rhythm: Ballooning stacks of virtual paper on electronic posting systems, parachuting in to convene for a day of committee meetings, followed by a board dinner and the following morning, a board meeting – and then a hasty collective scoot to the airport. Punctuated by the annual two day or so retreat.
Ironically, on the very same day that the principles were announced, CalSTRS disseminated a press release outlining their own changes to their governance principles (click here). One must wonder if the CalSTRS press timing was completely coincidental, particularly given dueling press releases on corporate governance principles are hardly an everyday event. Many of CalSTRS points mirrored the baker’s dozen group of CEO’s, specifically:
- Increasing board diversity while also ensuring board competency;
- Executive compensation, including peer group composition and enhanced scrutiny on equity grants – and particularly ones outside of established plans; and
- Demanding one share, one vote capital structures.
In summary, the group of CEO’s message on corporate governance represents a baseline – something for which companies in the lowest decile of governance practice can aspire. But with a wider cross section of leaders, it possible to imagine the group driving harder to have positions on the tough issues facing boards today – and describing clearly areas where dissonance occurs while addressing the tension behind such obvious underlying disagreement.