Future Students, Alumni & Visitors

Archive for the ‘Board and Committee Leadership’ Category

« Older Entries Newer Entries »

J.P. Morgan post-game analysis

May 23

Posted in Board and Committee Leadership, Governance of Financial Institutions | Comments Off on J.P. Morgan post-game analysis

I was interviewed by BNN where I said that what proponents for the split of CEO and Chair at JP Morgan had going against them this week was that the stock was up 50% and that the split would occur to an incumbent CEO, Jamie Dimon, as opposed to a new CEO, where the decision to split the roles by a board is easier.

Shareholders have spoken and the vote was almost a third in favor of having a separate Chair and CEO. However the risk committee directors received less than 60% support for their continued tenure on the board.

What are we to take from this, from a governance and accountability perspective?

First, the directors who received less than 60% should all be replaced. New directors should demonstrably possess solid risk and banking expertise – including a full understanding of complex derivatives – to sit on a board of this type. Management, including the Chairman, should have no say whatsoever as to who these directors are. Indeed the incumbent board should look to shareholders for suggestions.

Second, there is not a single new argument in the lead up to the chair-CEO vote that was not already mentioned in the Canadian context when Canadian banks ten years ago had combined roles, but now have separate chairs. I remember many bank chair-CEOs making impassioned arguments as to why they should keep the chair role, with the “support” of their boards. Shareholders and regulators eventually won this battle.

Share price or a threat to leave by Mr. Dimon is likely what swayed shareholders away from voting more fully for the split.

These are both troubling from a governance perspective. Directors should be free and empowered to take decisions that are best for the company and shareholders in the long term – decisions that may even result in short term share price decline. Share price also reflects multiple inputs, and it’s not certain that splitting the roles for governance purposes would affect share price irreparably.

Second, and more important, a CEO who threatens to leave is a red flag – or should be – for any board. It may signal lack of internal succession planning. No one is irreplaceable and the “leaving” card should be called by more boards – even in pay negotiations – through proper succession planning, that is to say internally ready candidates at all times.

Lastly, the decision of a separate chair vs. a lead director is vulnerable to the narrative that “it depends.” This is impenetrable and can reflect more ego, hubris and board capture. At some point, the decision on chair vs. lead director should be an objective standard, not subjective one. It is the same with standards for director independence.

There is a fundamental difference between a chair role and a lead director role. The chair role is stronger. Regulators should be more prescriptive and say the roles should be split as a matter of good governance and preventing a concentration of power absent accountability. They have done so in Canada and we have fared very well.

American Banks Should Split the Chair and CEO Roles

Apr 12

Posted in Board and Committee Leadership, Independence and Role Clarity | Comments Off on American Banks Should Split the Chair and CEO Roles

Jamie Dimon and Lloyd Blankfein (Chairs and CEOs of J.P. Morgan and Goldman Sachs, respectively) should be relieved of their Board Chair responsibilities.

Here is why.

Consider how two hypothetical – but typical – board meetings play out: the first occurs with a Chair and CEO role combined in one person, with another director as a “Lead Director,” and another board meeting occurs with Chair and CEO roles separated into two people.

In the first board meeting, when one person occupies both the Chair and CEO roles, there is a very high concentration of power. Another director independent of management acts as a “lead” director and the counterpoint. The Lead Director may sit next to the Chair and CEO in the boardroom, but the Lead Director does not chair the actual board meeting. Nor do lead directors have final say when push comes to shove over the board agenda. Nor do they establish the information flow the board receives, as good chairs do.

The Lead Director has influence, but the Board Chair has actual authority. What gets discussed, when and how, is the purview of the chairperson of any board. The most important role a Board Chair has is to control the discussion, who speaks and in what order, and how decisions get made (or not). These meeting levers shape outcomes. If the person controlling the discussion, the information and the agenda (i.e., the chair) has a vested interest in the outcome and is the same person (i.e., the CEO), there is an inherent bias in all decisions. The board’s fundamental oversight role in controlling management is compromised.

When I observe the second type of board meetings — with non-executive, independent Chairs and separate CEOs (i.e., two separate people), the dynamics are very different. The board meeting is almost “bi-polar” in nature. There is a natural counterpoint when debate happens because the CEO is separated out of the critical proposal and approval parts of the discourse. Power is more flat. Directors feel free to speak up because the chair is one of them (independent). It is hardly surprising to see the lead director role marginalized by a strong personality who controls a board meeting. CEOs have very strong personalities. Directors are more likely to weigh in and exercise independence if they aren’t blocked by their chair.

At one point, Canadian bank boards argued – unsuccessfully – and of course their CEO and Chair incumbents were the primary proponents, that good governance could include the fundamental conflict of a combined Chair and CEO role. “Good” governance, the argument goes, could include having exclusively independent committees, an effective lead director, and an effective reporting and assurance structure. Proponents for maintaining the Chair and CEO roles also argued whether to split of not “depends on the personalities,” somehow implying an effective chair who has a good working relationship with a CEO could not be found. The real resistance to splitting the roles were the egos and hubris of the incumbents, and a captured board beholden to them.

Shareholders and regulators prevailed in Canada, the UK, Australia and New Zealand, where non-executive chairs are the norm. In the most recent set of governance reforms of 2013, for example, Canada’s financial institution regulator stated that the role of the Chair should be separate from the CEO, as this separation “is critical in maintaining the Board’s independence, as well as its ability to execute its mandate effectively.” Back in 2003, OSFI (Canada’s financial institution regulator) stated that both a non-executive chair versus a lead director could achieve board independence. The choice was up to the board, OSFI stated. Regulators have since progressed, advising that the roles can and should be split, for all federally regulated financial institutions, for the sake of good governance.

Having a non-executive chair separated from the CEO role (two different people) won’t guarantee success or prevent failure. Academics cannot prove a systemic relationship between board leadership and performance because chair effectiveness is so difficult to measure. But this can be posited: if the chair is effective, there is a much greater likelihood of better governance than relying on the effectiveness of a lead director. I have yet to see an effective lead director who approaches how effective a separate chair can be. A lead director role is institutionally more passive. Ask yourself if Jamie Dimon had to answer to a separate no-nonsense Chair who understood banking and risk whether the J.P. Morgan Chase’s risk meltdown would have occurred. (See the Senate report here.) The roles of a Lead Director and Board Chair are different. More and more American corporations are moving towards effective, non-executive chairs. Banks should not be dragging their feet.

Does Your Board Chair and Governance and Nominating Committee Need A Reset?

Mar 8

Posted in Board and Committee Leadership, Shareholder Accountability | Comments Off on Does Your Board Chair and Governance and Nominating Committee Need A Reset?

I am currently interviewing shareholder activists, hedge funds and private equity leaders on changes to public company boards to make them more focused on value creation and company performance. I am also interviewing leading directors and CEOs. My research reveals a disconnect between how many boards operate and how shareholder advocates believe they should operate.

For a board to operate effectively, it starts with an independent and effective Board Chair and Governance and Nominating Committee, which are the leadership and inner workings of a Board. It is here where governance accountability is established and good directors are selected, or not.

The focus since Sarbanes Oxley has been on the Audit Committee, and since Dodd-Frank on the Compensation Committee. But without an effective Board Chair and Governance and Nominating Committee, management accountability to the board, and board accountability to shareholders will be undermined.

If you want to make your Board more focused on company performance and value creation, ask yourself whether your Board Chair and Governance and Nominating Committee can answer “yes” to most of these questions, based on my interviews, in no particular order:

  1. Has the Board set standards for a vigorous value creation process, and does its value maximization plan clearly and simply spell out key timelines, milestones, targets, and individuals accountable for each key plan component and specific results? (Is the Board’s plan as good as or better that what an activist shareholder can provide? It should be.)
  2. Does each Director have the background into the company, the business model, the industry and markets to fully understand the value drivers and associated risks? (If not, does the Chair and Board have the backbone to replace those directors?)
  3.  Leadership goes well beyond whether the Chair is independent or not. Does the Board Chair possess the following attributes: Shareholder mindset, leadership, understanding of the value creation process and the capital markets, ability to view things holistically, an ethic of accepting personal responsibility, industry experience, and no desire for CEO role? (If not, is the Governance and Nominating Committee strong enough to recommend to the Board to replace the Chair?)
  4. Do the Board and Board Chair have the will to hold management to account for results and the courage to act decisively when needed?
  5. Does the Board ensure direct links to performance and value creation and the need to hit certain targets before any executive incentive compensation kicks in?
  6. Does each Director have a meaningful portion of his or her own savings invested in the company?
  7. Has the Governance and Nominating Committee recommended to the Board adopting shareholder accountability practices and removing entrenchment devices and other restrictions?
  8. If or when needed, does the Board and each Board Committee utilize resources and advisors independent of management who represent the interests of shareholders?
  9. Does the Board Chair and Governance and Nominating Committee look to shareholders for prospective directors, rather than to management?
  10. Does the Governance and Nominating Committee ensure that all governance terms of reference been redesigned to reflect the Board’s focus on value creation and company performance? (Many times these terms of reference written by management keep the board at bay.)
  11. Does the Board Chair and other Directors engage regularly and directly with key shareholders, without the presence of management? (The vast majority of boards do not meet with shareholders.)
  12. At these Director-Shareholder meetings, are the following matters covered off: Value creation and company performance; status of governance initiatives; board and committee composition and renewal; risk governance; and the governance of executive compensation?

If you answered yes to all questions, or even almost all, you likely have a truly outstanding Board Chair and Governance and Nominating Committee. You may even wish to apply for a governance award, here.

If you cannot answer yes to the majority of these questions, you have work to do.

Join me in my next blog where I will discuss “What makes for a high-performance Director?” based on about 30 interviews with shareholder advocates, search firms and members of the NACD 100 and Top 100 CEO listings.

Potential Regulation of Proxy Advisory Firms: CSA Consultation Paper 25-401

Aug 25

Posted in Board and Committee Leadership, Shareholder Accountability | Comments Off on Potential Regulation of Proxy Advisory Firms: CSA Consultation Paper 25-401

Here is my letter to the Canadian Securities Administrators on the potential regulation of Proxy Advisors:

Should Proxy Advisory Firms Be Regulated? Yes.

I am drawing on my own research as well as materials I consulted recently in designing and delivering a new course at Harvard University, including teaching materials provided to me by Stanford University researchers (Larcker and Tayan).

The Canadian Securities Administrators has asked whether proxy advisory firms should be regulated. (Proxy advisory firms, such as Institutional Shareholder Services and Glass Lewis, which is owned by Ontario Teachers Pension Plan, provide governance assessment and recommendations to institutional shareholders on their voting at annual meetings of companies.)

In my view, proxy advisory firms should be regulated for three important reasons.

Conflicts of Interest

Proxy advisory firms also provide consulting services to companies to improve their governance score. This would be analogous to me as a teacher providing tutorial services for money for students to improve their grade. Or credit rating agencies receiving fees for other services other than an independent rating of the creditworthiness of the company. The business model for proxy advisory firms needs to change such that there is no non-rating services offered by them. Similar to auditors being restricted only to the audit (S-Ox), and compensation consultants now being restricted only to compensation assurance services to the board (Dodd-Frank), this practice needs to broaden such that any firm or individual providing independent assurance of governance (including governance advisory and search firms) should not have a consulting revenue stream, and should not provide any services to management or the company other than the assurance service provided to – or in respect of – the board or committee.

Having an alternate revenue stream to the provision of governance assurance services undermines the independence and objectivity of the assessment as the assurance provider is assessing his or her own work, or that of his or her colleagues within a firm. Moreover, a commercial conflict of this nature undermines the appearance and confidence in the marketplace that the assurance provider is not unduly influenced by proprietary or commercial interests. Having firewalls or separate business units within a firm does not address the reasonable perception of conflict, nor provide adequate safeguards given non-financial and personal/career influence.

Lack of Qualitative Assessment of Governance Quality and Predictive Validity on Shareholder Value

Second, based on my review, there is limited peer-reviewed evidence at best that proxy advisory firms measure governance quality in the main, or that which they do measure predicts shareholder value. These commercial firms possess a business model predicated on volume-based, externally measureable metrics. What is measureable, such as structural independence governance variables, such as independent chairs and directors, independent committees, share ownership, etc., do not necessarily impact board effectiveness or shareholder performance.

The above quantitative Stanford researchers actually go so far as to suggest “no evidence” (at page 161 of their book) for certain of these variables. Other variables offer “mixed” or “modest” evidence, while others (such as busy or interlocked boards) offer more persuasive evidence. Indeed the academic research also has not found a systemic relationship between governance rating systems (including G and I Indexes) and the predicting of long-term shareholder performance. Indexes based on entrenchment and anti-takeover provisions arguably do not measure board effectiveness.

Unfortunately, given the above lack of predictive validity, companies change certain governance practices to improve their scores when there may be limited empirical evidence that the purported practice will have impact on board effectiveness or firm performance. This pressure to change should not be the case.

What are relevant – so far as board effectiveness is concerned – are qualitative factors such as director qualifications (competencies and skills), engagement, leadership and board dynamics. These factors are more difficult, and in some cases not possible, to measure from outside a boardroom. I note the inconsistencies in proxy advisory firms’ ratings where the same company received divergent ratings from different proxy advisor firms, or companies that experienced governance failure formerly received high ratings (and in a few cases, awards from shareholder or other groups) from proxy advisory firms.

Proxy advisory firms, if they are purporting to measure governance quality, (i) should be required to assess and incorporate qualitative and firm-specific factors into their ratings and recommendations, (ii) should have the expertise and resources to do so, and (iii) should have a process for independent review, audit, contestation and arbitration if necessary. The personnel and sources consulted to produce a proxy advisory report should also be disclosed. See the paper by Leblanc et al., here and search “The Governance of Proxy Advisors.”[1]

Lack of Transparency

Third, the transparency of proxy firms should be increased. Proxy advisory firms’ rating methodologies and weightings accorded to various factors are divergent. If they were measuring governance quality with rigor, we would expect to see convergence, such is the case with credit rating agencies. Not surprisingly, individual companies may receive different ratings depending on the proxy advisory firm. This inconsistency needs to be addressed.

Governance ratings according to Stanford researchers who study them were found to have little predictive validity among the ratings of any of the three proxy advisory firms examined. The authors go on to write (Larcker and Tayan, 2011, p. 446-447), “the study found low correlation among the ratings of the three firms, low correlation between the ratings of each firm and future performance, and low correlation between the ratings of Risk Metrics/ISS and the proxy recommendations of Risk Metrics/ISS. The authors concluded that “these governance ratings have either limited or no success in predicting firm performance or other outcomes of interest to shareholders. … Our view is that  … the commercial ratings contain a large amount of measurement error. … These results suggest that boards of directors should not implement governance changes solely for the purpose of increasing their rankings.” [footnote omitted].

The use of and reliance upon ratings and proxy advisory services by institutional shareholders should also be transparent and accessible on the institutional shareholder website. (See the above paper by Leblanc et al..)

Conclusion

Boards of directors criticize proxy advisory firms for their ‘check the box’ and ‘one sized fits all’ approach to corporate governance; the enormous influence that they have; and their lack of transparency and accountability – in the governance field – when these firms and shareholders they serve insist on transparency and accountability from others. It seems to me that there is merit in concerns that boards have. More importantly however, the empirical evidence does not support many of the metrics being used by these firms, and ignores or diminishes others.

I hope this commentary is useful to your review.

Sincerely,

 

Richard W. Leblanc, PhD

[1] Leblanc, Richard, et al., “General Commentary on European Union Corporate Governance Proposals,’” International Journal of Disclosure and Governance (2012) 9:1, 1-35, where transparency, influence, inaccuracy, consulting services, institutional investor regulation and increased competition are discussed in greater depth. See online version here: http://www.palgrave-journals.com/jdg/journal/v9/n1/full/jdg201124a.html

Canadian Pacific is a Teachable Governance Moment

Apr 20

Posted in Board and Committee Leadership, Independence and Role Clarity | 2 Comments »

The fight for Canadian Pacific Railway (CP) by activist investor Pershing Square demonstrates several shortcomings in the public company governance model and what can be learned from private equity. CP and RIM are significantly underperforming Canadian companies. There are numerous others. The question is where is the board?

The current corporate governance model is largely focused on compliance, not on value-creation. Most regulations short shrift the board’s strategic and value creation role. Canadian guidelines address strategic planning in one sentence, at 3.4 (b). The NYSE rules do not contain the word “strategy.” Educational programs are overwhelmed by auditors, lawyers and pay consultants. Boards have become bureaucratic traffic cops and the trend is continuing after 2008. How would codes and educational programs look if they were drafted and taught by long-term active investors?

Regulators in large measure are to blame. They overemphasize structural board independence at the expense of industry knowledge and shareholder mindset. The separation of chair and CEO and having a plethora of independent directors accomplishes little unless there is a clear understanding of roles. Most chair and director position descriptions are little more than high-level one or two page compliance documents written by lawyers designed to keep directors at bay. Directors are selected for independence and profile because that’s what the regulators want. Yet scholars know research does not support independent directors and the creation of shareholder value. What is missing? What can we learn from activist investors and private equity?

Here are some facts about CP according to Pershing Square’s materials and presentation:

  • All directors own < 1% of stock and it was given to them, not bought;
  • Four COOs and three CFOs have been replaced in the last five years;
  • CP has consistently underperformed across industry peers, yet the CEO met 17 of 18 objectives set by the board;
  • The cost of management as a percentage has doubled;
  • There has been a moving of targets by the board, and these targets have been meaningfully lower than CN’s;
  • There has been a lack of rail experience on the board, shareholder representation or equity ownership; [CP did not have any railroad expertise to drive the value creation process on the board (other than the CEO) until Bill Ackman first launched his activist efforts]
  • If one director had $100M of his or her own wealth invested, the CEO would be replaced, Pershing Square said;

Deep dives such as the above by sophisticated activists such as Den Loeb and Bill Ackman need to be undertaken by boards themselves. This dive need not be overly complex. Look at Ironfire Capital’s analysis of the New York Times. How many boards have the skills to do this, I wonder? The approach Bill Ackman brings is not exclusive in its applicability to under-performers. The fundamental question is how many companies are under-performing relative to their potential, just not to the extreme extent of CP? And does this speak to a more robust corporate governance model on a wider scale?

We can learn from private equity and the nature of board engagement and shareholder value creation. According to experienced chair and activist investor, Henry Wolfe, “Numerous studies have been done of the performance and value creation results of private equity portfolio companies compared to their public company peers. At least in all that I have seen, the studies clearly demonstrate that private equity companies significantly outperform.” Wolfe goes on to say, “The implications of these comparative results for public companies is or at least should be staggering to those who serve on or advise public company boards. Adding fuel to this point Ernst & Young and other studies, including by McKinsey, found that the primary driving force for this out-performance was the PE Corporate Governance Model.” See the following link to an Egon Zehnder Private Capital Thought Leadership article regarding the work they did to learn more about a McKinsey study on Private Equity.

Michael Jensen at Harvard from his panel role in the 2007 Morgan Stanley Roundtable on Private Equity and its Import for Public Companies, said “In fact, my sense is that the due diligence process that the buyout firms go through in vetting and pricing a deal causes those principals and their managers to learn more about the business than has ever been known since it was a public company.”

This should not be the case if the public governance model worked. A key disconnect is director-shareholder accountability, which is not the case in private equity.

The nexus between public company boards and shareholders who own the company is limited at best, and this affects motivation and accountability. Boards continue to entrench themselves through staggered elections, at the expense of shareholder value. Most boards do not actually engage with shareholders directly other than at a perfunctory annual meeting. Shareholders cannot even propose directors in the proxy circular. A recent proposal by a group of Canadian investors is recommending (see the “Roxborough Initiative”) not only that shareholders select but also that shareholders – not management – compensate directors. This would address incentives and accountability. Director performance reviews should also be shared with shareholders and shareholders should have a say on board chairs. We are a long way from this type of meaningful board-shareholder accountability.

It is time to push the envelope and rethink the current model of corporate governance, in terms of how directors are selected, directors’ fundamental understanding of the business and the value creation process, the role of the non-executive chair, and director accountability to shareholders.

 

« Older Entries Newer Entries »