A recent discussion that I moderated at the Corporate Directors Forum at the University of San Diego focused on the changing regulatory landscape triggered by the financial crisis. The focus was on the changing rhetoric in the corporate governance debate, and whether the rhetoric matches the proposals being advanced – i.e., does the “talk-the-talk” fit with the “walk-the-walk”.
The presentation that framed the discussion first outlined current legislative and regulatory proposals for changes in corporate governance, including changes regarding board structure, director elections, shareholder proxy access, risk management and compensation. The current corporate governance landscape includes proposed or actual reforms to these areas from federal legislation, SEC rule-making, state corporate legislation, changes to New York Stock Exchange rules, and stockholder proposals. The presentation mentioned recent comments on the regulatory and legislative landscape, including the following:
- “The current economic crisis has led many investors to raise serious concerns about the accountability and responsiveness of some companies and boards of directors to the interests of shareholders, and has resulted in a loss of investor confidence.”– SEC Chair Mary Schapiro, Proposed Rules on Proxy Access
- “During this recession, the leadership at some of the nation’s most renowned companies took too many risks and too much in salary, while their shareholders had too little say. This legislation will give stockholders the ability to apply the emergency brakes the next time the company management appears to be heading off a cliff.”– Senator Charles Schumer, introducing the Shareholder Bill of Rights Act of 2009
- “…among the central causes of the financial and economic crisis that the United States faces today has been a widespread failure of corporate governance.”– Shareholder Bill of Rights Act of 2009
- “By creating a large public demand for reforms, the current crisis offers another opportunity to improve governance arrangements. This opportunity should not be missed.”– Prof. Lucian Bebchuk
The presentation then covered some of the purported causes of, and the suggested cures for, the financial crisis that have been advanced from several quarters, including a lack of “accountability” of boards/management to shareholders, inappropriate compensation levels and incentives, insufficient risk management controls, and pressures from “short-termism.” The presentation mentioned the stated goal of the Shareholder Bill of Rights Act of 2009 – “to prioritize the long-term health of firms and their shareholders” and to create “more long-term stability and profitability within the corporations that are so vital to the health, well-being, and prosperity of the American people and our economy” – and raised the question whether there is a disconnect between the stated goals of current legislative/regulatory initiatives and the reality of what they represent – a wish list for governance “reformers” that is being opportunistically pressed by hijacking a financial crisis. Pertinent comments on these issues from various sources included the following:
- “Excessive stockholder power is precisely what caused the short-term fixation that led to the current financial crisis. …The real investors are mostly professional money managers who are focused on the short term.“It is these shareholders who pushed companies to generate returns at levels that were not sustainable. …The pressure to produce unrealistic profit fueled increased risk-taking. And as the government relaxed checks on excessive risk-taking (or, at a minimum, didn’t respond with increased prudential regulation), stockholder demands for ever higher returns grew still further. It was a vicious cycle.“Thoughtful observers of corporate governance have recognized the direct causal relationship between the financial meltdown and the short-term focus that drove reckless risk-taking.”
– Martin Lipton, Jay W. Lorsch and Theodore N. Mirvis, Schumer’s Shareholder Bill Misses the Mark, Wall St. Journal, May 12, 2009.
- “It is true that shareholders sometimes encourage companies, including investment banks, to ramp up short-term returns through leverage.”“Institutional shareholders should recognize their responsibility to generate long term value on behalf of their beneficiaries, the savers and pensioners for whom they are ultimately working.”– International Corporate Governance Network (ICGN), Statement on the Global Financial Crisis (Nov. 10, 2008).
- “Shareholders, boards and [management] and those involved in legislative and regulatory reform initiatives should give special consideration to the long-term nature of corporate wealth-generating activity and strive to avoid undue short-term focus and pressures that may impede the capacity of the corporation for long-term investments and decisions necessary for sustainable wealth creation.”– ABA Task Force Section of Business Law Corporate Governance Committee on Delineation of Governance Roles & Responsibilities, Aug. 1, 2009, recommending that boards: “Acknowledge that at times, the company’s long-term goals and objectives may not conform to the desires of some shareholders….”
- “[I]n recent years, boards, managers, shareholders with varying agendas, and regulators, all, to one degree or another, have allowed short-term considerations to overwhelm the desirable long-term growth and sustainable profit objectives of the corporation. . . .Restoring that faith [in corporations being the foundation of the American free enterprise system] critically requires restoring a long-term focus for boards, managers, and most particularly, shareholders—if not voluntarily, then by appropriate regulation.”“Encouraging investors and intermediaries representing investors to adopt a long-term perspective will ultimately encourage and empower boards of directors to adopt long-term strategies for growth and sustainable earnings, and to rely on long-term, forward-looking metrics in the consideration of compensation and performance incentives.”“The trend toward greater shareholder power as encapsulated in legislative proposals under consideration in the 2009 legislative session should be accompanied by greater investor and intermediary responsibility.”
- Aspen Institute, Overcoming Short-termism: A Call for a More Responsible Approach to Investment and Business Management, Sept. 9, 2009.
The presentation canvassed a series of issues in the debate regarding appropriate responses, including: state v. federal responses; private ordering v. “one size fits all”/default rules; long-term value v. stockholder empowerment; the accountability/power of boards, management, stockholders, and regulators; the separation of “ownership from ownership” — and non-stockholder constituencies; the independence of boards v. knowledge/experience/judgment; “durable”/“sustainable” performance v. takeovers; “opportunism” and the “inner populist”; and the connection of “cure” to “cause”.
The presentation summarized the following corporate governance proposals in the four areas of corporate governance:
1. Board Structure
- Separation of board chair/CEO (Shareholder Bill of Rights Act of 2009 – the Schumer Bill; Shareholder Empowerment Act of 2009)
- Elimination of classified boards (Shareholder Bill of Rights Act; Restoring Financial Stability Act of 2009 – the Dodd discussion draft)
- Enhanced disclosures – description/explanation of corporate leadership structure (whether and why separate board chair /CEO or lead independent director; additional disclosure of directors’ skills and experience) – SEC final rules (Dec. 16, 2009)
- Majority voting – plus required resignation (Shareholder Bill of Rights Act; Shareholder Empowerment Act; Restoring Financial Stability Act)
- Broker non-votes – NYSE Rule 452 change (approved by SEC – July 2009; effective for meetings after Jan. 1, 2010)
2. Stockholder Proxy Access
- Delaware legislation (April 2009) – Authorizes stockholders or board to adopt a by-law requiring company to include stockholder nominees in its proxy materialsNon-exclusive list of conditions:
- limit number of nominees
- minimum holding period and beneficial ownership level (including derivatives)
- require disclosure about stockholder and its nominees
- preclude use by stockholders seeking to acquire above x%
- Model bylaw published – WLR&K form limits proxy access to 5% stockholders, one-year holding period, one candidate, 1/3 of seats maximum, no “Trojan Horse” takeovers
- SEC proposed Rule 14a-11 – mandatory rule for stockholder access: 1% stockholders (with aggregation), one-year holding period, ¼ of seats maximum, “first-nominated” priority
- Federal legislative proposals – mandatory rule for stockholder access: 1%, two-year holding period (Shareholder Bill of Rights Act)
3. Risk Management
- Mandatory board-level risk committee (Shareholder Bill of Rights Act)
- Enhanced disclosures on risk management (SEC rules – Dec. 16, 2009)
- Department of Treasury statement on “reform” goals (June 10, 2009)
- Draft Treasury legislation (requiring annual and merger-proxy “Say on Pay” votes and compensation committee independence)
- Financial Stability Board implementation standards agreed to by all G-20 nations and related reforms
- Enhanced proxy disclosure related to implications of compensation for risk-taking incentives
- Federal Reserve guidance on incorporating analysis of compensation structures into supervisory reviews
- FDIC notice of proposed rulemaking on adjustment of deposit insurance assessment rates based upon compensation structure reviews
- Special Master (a.k.a. “Pay Czar”) rulings on compensation at firms receiving “exceptional” taxpayer assistance
Finally, the presentation addressed the question whether “poor” corporate governance caused the financial crisis, and presented some empirical data pertaining to the question. Of the 15 S&P 500 companies with the worst-performing stocks in 2008, 80% did not have staggered boards, 80% did not have a poison pill in place and 73% had majority voting or a director resignation policy. The biggest decliners of the S&P 500 were less likely to have staggered boards than the average S&P 500 company (20% v. 33%) and no more likely to have a poison pill. Reference was also made to the recent paper by, Professor Brian R. Cheffins of Cambridge University, Did Corporate Governance “Fail” During the 2008 Stock Market Meltdown? The Case of the S&P 500 (Business Lawyer, 2009),which concludes: “[T]he case is not made for fundamental reform of current corporate governance arrangements.”
The slides from the presentation are available here.