I once asked a fellow law school graduate how he did in school. He replied with great enthusiasm, “I graduated in the top 90% of my class!”
A Massey Energy spokesman who announced that its three directors standing for election had won by a landslide reminds me of that retort when I read the announcement. Directors Gabrys, Moore and Phillips won their respective reelections by votes of 55.36%, 55.09% and 57.83& respectively.
A landslide? Surely Massey officials jest. Read more »
A series of posts on Race to the Bottom this week has made much about the likely prospect of “Say on Pay” becoming the law of the land if the Dodd bill addressing financial reform passes in the coming weeks, which it is likely to do. However, the practical effect of this provision of the Dodd bill on executive pay seems negligible.
For those unfamiliar with “Say on Pay,” this is a concept first put forth by shareholders that calls on companies to submit all executive pay decisions to a vote of the company’s shareholders prior to going into effect. Like the provision in the Dodd bill, this shareholder approval ritual is advisory. Thus, directors can ignore the wishes of shareholders if they so choose.
In the short-term, it is unlikely that this provision will have any impact on the vast majority of public companies. Race to the Bottom notes that only a few companies that have submitted pay plans to shareholder approval have experienced any blow back from their investors. Citing the situation at Occidental Petroleum, shareholders voted down a compensation plan for the company’s CEO Ray Irani, a perennially overpaid executive who has been a lightening rod for investors for many years. Undoubtedly, when Say on Pay becomes the law of the land, there will be a few more of these votes getting majority status.
While shareholder approval of executive compensation is a good thing for some obvious as well as less obvious reasons, as a practical matter, very little will change in the short-term. What remains unchanged is the fact that institutional investors largely give companies a pass when it comes to pay practices. Despite the railing of pitchfork capitalists that things must change, those major investors “pulling the lever” at proxy voting time have no incentives to change their voting practices. There are several reasons for this.
First, a substantial percentage of institutional investors – investment managers, corporate pension funds, insurance companies and some pension funds – have policies when it comes to executive pay that I would characterize as “but for the grace of God go I.” By tackling the executive pay head-on as large investors, these institutions risk impacting their very own pay practices. While most of these investors would not admit to this practice, as a practical matter, this is the consequence
Second, institutional investors defer to their professional proxy voting advisors – ISS/Risk Metrics, Glass Lewis, et al. – in order to untangle the complicated mess that is designed to obfuscate the executive pay setting process. A quick glance at any company proxy statement will confirm the fact that 60 to 80 percent of proxy statements are devoted to executive pay discussions.
The proxy advisors have responded in an equally complicated fashion both to analyze these complicated pay setting processes as well as justify their own existence to their paying clients by demonstrating their intellectual prowess on the subject. For instance, ISS/Risk Metrics employs multiple regression analysis and a two stage assessment of just one aspect of company executive pay setting. While this approach gets the job done, the entire process from both the issuer and investor perspectives only obscures the problem.
The good news in all of this is that the question of executive pay will now be addressed head on by shareholders. A procedural barrier preventing meaningful discussion about pay practices has been removed. What now must be done is to address excessive corporate pay practices and their underlying causes in a meaningful manner. This will require a better informed corporate electorate that can decipher the the arcane data that currently obscures greater understanding of the matter.
The 2011 proxy season should be an interesting test of shareholder mettle on this subject. While some executives may fear a firing squad of sorts from shareholders, as a practical matter, their investors will most likely miss their targets. However, in time, investors may become better shots.
What have we learned from the collapse of Lehman Brothers Holdings?
The report issued by a bankruptcy court examiner into the collapse of Lehman Brothers was released last week, sending shock waves through the business world. Aide from many details about high-risk business deals undertaken by the company, what has been most revealing to me is the blame laid on Ernst & Young, Lehman’s outside auditors. One would think that post-Enron, where the once venerable Arthur Anderson was extinguished in the blink of an eye, the remaining Big Four would be a bit more rigorous about their audit engagements. Apparently not.
What came out of the Enron disaster was the Sarbanes Oxley Act (SOX), which among other things imposed increased responsibilities on companies and their auditors to conduct and verify their internal controls. In addition, Congress and the SEC severely limited outside accountants from engaging in non-audit work with the firms they were auditing.
Say hello to the “rule of unintended consequences.”
An interesting thing happened in 2001. That was the year that auditors were prohibited from doing other consulting work for their corporate audit clients. In the case of Lehman Brothers and Ernst & Young, that event seemed to have just the opposite effect in that the auditor’s fees skyrocketed. From 1999 to 2007, the last year auditor fee data was reported to Lehman’s shareholders, Ernst & Young’s fees increased 7 fold from $5.3 million to more than $31 million. While some of the increased revenues can be attributed to the additional work created by Sarbanes Oxley compliance, it remains interesting from a shareholder perspective that the numbers accelerated in such rapid fashion.
The following chart reveals the dramatic climb in E&Y’s fees for the 9-year period. It suggests that, in terms of fees collected from it’s client, the risk of “not biting the hand that feeds you” increased dramatically.
What we see is that, in the case of Lehman Brothers and Ernst & Young, the auditor was able to recoup their non-audit fees in spades. While the apparent conflict of interest that was eliminated by SOX was eliminated, the motivation to rigorously assess the financial dealings of Lehman Brothers may have taken a back seat to the revenues generated from the long-term engagement with Lehman Brothers.
I have no doubt that Ernst & Young officials would rigorously argue that no such conflicts existed. However, when “credible evidence” suggests that “accounting gimmicks” were not uncovered by Ernst & Young to shareholders, investors can only wonder.
So what have we learned here?
Despite SOX reforms, there are still risks to investors from shoddy audit oversight. Auditors are still subject to enormous pressure from unscrupulous clients who try to hide risk from their investors. Long-term engagements by companies of their outside auditors pose real risk to investors.
“It has not been shareholders who have botched the operations of some of our country’s largest financial institutions. Yet they have borne the burden. Collectively, they have lost more than $500 billion in just the four largest financial fiascoes of the last two years. The CEOs and directors of the failed companies, however, have gone largely unscathed. Their fortunes may have been diminished by the disasters they oversaw, but they still live in grand style. It is the behavior of these CEOs and their directors that needs to be changed. If their institutions and the country are harmed by their recklessness, they should pay a heavy price — and one not reimbursable by the companies they have damaged nor by insurance.”
Warren Buffett’s letter to shareholders in Berkshire Hathaway’s 2009 Annual Report
Okay, given that most director elections are uncontested, you might think that giving any consideration about how you vote for a director is meaningless.
Wrong.
In fact, there are a number of examples where shareholders have sent a message to directors that have brought about profound changes in the corporation. The most immediate example I can point to is the substantial number of votes cast against Bank of America’s CEO and Chairman Ken Lewis in the Spring of 2009. By October, Lewis was gone.
Shareholders can have an impact on the outcome of director elections if they vote their proxies.
While the dramatic events at Bank of America made it obvious to many of the company’s shareholders that Lewis had to go, for investors at other companies, the reasons for voting against a director or directors might not be so obvious. Therefore, I have put together this list of 12 factors to consider when voting for or against a slate of directors at a public company:
Director Qualifications
1. Does a director attend at least 75% of the director meetings?
This is a fundamental question that goes to whether a director is actually doing his or her job. Look at the company proxy statement in the director section for attendance records of individual directors.
2. Does a director sit on too many other boards?
As a general rule, a director who sits on too many boards (3 total) cannot possibly serve the interests of shareholders at your company. If your company is facing a significant challenge, a director should probably not be sitting on any other boards.
3. Does the director have the necessary skills to do his or her job as a director?
While regulations now require directors to have financial experience if they serve on the board’s audit committee, look for other qualifications that a director has or perhaps shouldn’t have when serving on the board. One factor to consider is if there are too many CEOs from other companies serving on the board, particularly on the compensation committee.
4. Does a director have conflicts or other disqualifications that raise questions about his or her ability to serve the interests of shareholders?
While directors are identified as being independent or insiders and the proxy statement must include possible conflicts that individual board members might have, look for other factors (social, board interlocks) that might suggest that he or she is not qualified to serve on the board.
5. Is the director sufficiently independent of management of the company?
Look to the proxy statement to determine if a director is independent of management. The document spells it out. This doesn’t get at every possible relationship between the director and management but it is the only way to easily sort out all but the most subtle examples of possible conflicts and lack of independence.
Board Independence
6. Is the board as a whole sufficiently independent of management of the company (1/2 to 2/3 of the directors should be independent)?
After analyzing who on the board is independent, add up the numbers: at least 2/3 of the board should be independent of management. This helps to ensure that the interests of shareholders, not management, are being served.
7. Are key committees (Audit, Compensation and Nominating) of the board completely independent of management of the company?
This is a hard and fast rule. There should be no insiders on any key committee of the board. NEVER. These specific committees are delegated with important responsibilities to protect shareholders. Having management directors sitting on these committees is like handing the keys to the hen house over to the foxes.
Board and Company Performance
8. Have key committees of the board adequately performed their duties?
Look to see if the company has experienced any problems associated with the committee in question. Examples abound here. Has the company experienced financial troubles? Is executive compensation out of control? Is the average tenure on the board seemingly long? This is about committee performance and it goes to the core of what directors are or aren’t doing on behalf of shareholders.
9. Has the company performed well over the long-term?
Look at long-term performance of the company and consider whether the company has underperformed relative to its peers and relevant benchmarks. Do not get caught in the trap of using short-term measures, either good or bad ones. In today’s markets, one-year performance can be dramatic for a company but it could still be in the tank from a long-term perspective.
10. Overall, has the company conducted itself properly?
Consider if the company has been involved in scandals or crises over the previous year and also factor in how the company handled itself in the process. Does it appear that the board is “asleep at the wheel?” Perhaps it’s time for them to go.
11. Has the board been responsive to shareholders including implementing previously approved shareholder proposals?
Does the board have a demonstrated record of being responsive to shareholder concerns? Consider if the board has procedures in place for addressing shareholder concerns. Most important is whether the board has implemented shareholder proposals that have garnered majority support in previous years.
12. Has the company adequately addressed the views of other stakeholders?
Look to whether the company has addressed issues of concern to its stakeholders – customers, suppliers, communities in which it operates and so on. Recent examples include Toyota (recall), Comcast (customer service) and the myriad companies off-shoring jobs.
Remember, if you do nothing, that is you don’t vote your proxies, then the directors of your companies get reelected. Therefore, it is your job to look for reasons to vote against the directors standing for election or reelection. For more information about how to vote for directors, visit our Proxy Voting Strategies pages at the ProxyAnalyst.com.
follow: RSS