Corporate Governance Roundup

Board Diversity

The C$368.3 billion Canadian Pension Plan Investment Board will vote against the chair responsible for director nominations at the public companies it invests in if the board has no women directors.

Also on board diversity:

     Search firm Heidrick & Struggles has announced that on an annual basis at least half of its cumulative slate of initial board candidates presented to clients will be diverse, reaffirming a commitment to promoting diversity in board of director searches globally. Developed in collaboration with Stanford’s Rock Center for Corporate Governance, Heidrick & Struggles’ pledge is designed to increase the number of women and members of underrepresented groups considered by boards.

     “Now is the time to make public what we have been driving as a firm globally,” said Krishnan Rajagopalan, President and CEO, Heidrick & Struggles. “Today, we are making a pledge to our clients, candidates and employees: we commit that a minimum of half of the initial board candidates presented to clients globally on an annual basis will be diverse.” To accelerate this effort, the firm will proactively identify and interview diverse director candidates, with an emphasis on prospective directors who have not previously served on a corporate board. Each year, the firm will measure results and seek new ways to broaden and enhance global diversity efforts across each board search.

Political Contributions

One of the most respected voices in corporate governance, Leo Strine (Chief Justice of the Delaware Supreme Court), wrote an important piece about the failure of shareholders to exercise oversight of corporate political contributions:

     In recent years, there has been a heartening improvement in the self-awareness of the major mutual fund families – BlackRock, Vanguard, State Street, and Fidelity (the “Big 4”) – that have Worker Investors’ capital. This Big 4 has grown enormously because of the legal pressures that generate capital inflows to them every month from Worker Investors. To their credit, the Big 4 recognize that they have a duty to think and act in a way aligned with the interests of Worker Investors by encouraging the public companies in which they invest to implement business plans that will generate sound long-term growth. In fact, the Big 4 have recently recognized that unless public companies act in a manner that is environmentally, ethically, and legally responsible, they are unlikely to be successful in the long run. Thus, the Big 4 are more willing than ever to second-guess company management to fulfill their fiduciary duties.

     In one area, however, the Big 4 continue to have a fiduciary blind spot: they let corporate management spend the Worker Investors’ entrusted capital for political purposes without constraint. The Big 4 abdicate in the area of political spending because they know that they do not have Worker Investors’ capital for political reasons and because the funds do not have legitimacy to speak for them politically. But mutual funds do not invest in public companies for political reasons, and public company management has no legitimacy to use corporate funds for political expression either. Thus, a “double legitimacy” problem infects corporate political spending.

Buybacks

Buybacks hit a record $1.1 trillion this year. Bob Pisani of CNBC notes:

     It’s sad but true. Companies are obsessed with controlling earnings per share, which is the key to maintaining higher stock valuations. It is easier to control earnings per share by purchasing stock, and companies get addicted to that process. Buying back stock often provides an incremental boost to earnings per share growth, and when companies stop doing that, accomplishing that goal becomes more challenging.

     So the critics of corporate buybacks and dividend raises are correct. It is a form of financial engineering that does not do anything to improve business operations or fundamentals.

     It also plays into the hands of the people who were critical of the tax cuts, arguing that  obsessing over ways to boost stock prices helps the investing class but not the average American.

We note that many of these purchases occurred at a market high. And that it is almost unheard of for a compensation committee to adjust EPS targets to reflect the reduction in outstanding shares and that CEOs often sell into the buyback, both misaligning incentives. And there is some evidence that short-term gains from buybacks have more appeal to CEOs than investment in operations/employees/innovation (another way of looking at misaligned incentives). ValueEdge Advisors Vice Chair Nell Minow was quoted in a Wall Street Journal article about “The Investment That Cost Apple $9 Billion in 2018,” the buyback program.

     “If they made an acquisition that decreased in value this much, people would be up in arms,” said Nell Minow, vice chairwoman of ValueEdge Advisors, a corporate-governance consulting firm. “They have one job, and that is to make good use of capital.”

Corporate Directors: NACD Survey Results

The National Association of Corporate Directors has announced the results of its latest survey on corporate governance. It shows that while some progress is reported, boards still lag on shareholder priorities like diversity, ESG, cyber-risk, and board “fitness for purpose.”

Stilpon Nestor, Managing Director of Nestor Advisors Ltd. and Chairman of Aktis Ltd., made the following predictions in his keynote speech on the Future of Corporate Governance at the Nominee Directors Day of the Deutsche Investitions-und Entwicklungsgesellschaft (KfW DEG) in Cologne on September 28, 2018:

• Diversity at every level and of every kind will continue to grow.
• Private companies will increasingly have outsiders on boards, who in many cases will be “professional” challengers, instead of lapdogs.
• Stakeholders will figure frequently on board agendas – and on boards themselves, possibly as a result of regulatory changes.
• While public company disclosures in the OECD might be streamlined…
• …private company boards will become more demanding on regular disclosures, and so will their shareholders.
• A more holistic view of the firm will emerge through systematic cultural audits.
• Diversity, disclosure, and interactions between principal and their agents, as well as stakeholders will increasingly require high quality governance data which will increase demand for data platforms at every level.
• The DFIs’ [Development Financial Institutions] weight in the EM [Emerging Markets] governance area will continue to increase; they will become an important source of demand for diversity, disclosure and data thus becoming themselves an important driver of change.

SpencerStuart Board Index

The 2018 SpencerStuart Board Index has been released. Some of the highlights include:

• S&P 500 boards appointed 428 new directors during the 2018 proxy year, the most since 2004 and an increase of 8% from 2017.
• Fifty-seven percent (57%) of boards added at least one new director. Nearly two-thirds (65%) of the incoming class come from outside the most senior board and company leadership roles.
• Only 35.5% of the new directors are CEO-level – active or retired CEOs, chairs, vice chairs, presidents or COOs – down from 47% a decade ago.
• Forty-five percent (45%) of CEOs of S&P 500 companies are serving on one or more outside boards.
• Reversing a decade-long decline, 56% of the incoming class are actively employed.
• First-time directors represent 33% of the incoming class of S&P 500 directors. They are younger than their experienced peers and more likely to be actively employed (64% versus 53%).
• More than a quarter (25.5%) of the incoming directors are financial experts, up from 18% in 2008. Eleven percent (11%) – nearly half of the financial professionals – are experienced CFOs/financial executives. Directors with investing/investment management skills are increasingly joining S&P 500 boards. Ten percent (10%) of new directors bring an investor lens to the boardroom, up from 4% a decade ago.
• Seventeen percent (17%) of the incoming class are age 50 and younger, up slightly from 16% last year. Nearly two-thirds of the next-gen directors are serving on their first public company board. More than half (53%) are women.
• Progress in boardroom diversity is mixed. For the second consecutive year, women and minorities represent half of the class of new S&P 500 directors. Women represent a record-breaking 40% of the incoming class (up from 36% in 2017). Minority women are 9% of the new directors, up from 6% last year. But minority men (defined as African-American, Hispanic/Latino or Asian) represent just 10% of the incoming class, down from 14% last year.
• Annual assessments have become the norm for boards, and 98% of S&P 500 companies in our index reported conducting a board assessment over the past year. Only 38% – largely unchanged from 37% last year and 33% five years ago – report some form of individual director evaluations.
• Half of S&P 500 boards split the chair and CEO roles, up from 39% a decade ago: 30.5% of boards have an independent board chair and 80% report having an independent lead or presiding director.

Activism and Engagement

In Australia:

• Following a 46.3% vote in favor of a shareholder resolution about political lobbying, Origin Energy agreed to fully disclose its membership of industry organizations, such as the Business Council of Australia, and where their policies differ on climate change.
• Shareholders of Whitehaven Coal voted in favor of a resolution calling on the company to comply with the provisions of the Paris climate accords. Shareholders also opposed the CEO pay plan and called on the chairman to reduce his outside obligations.
• Telstra is considering an overhaul of how it calculates executive bonuses after suffering a first strike from shareholders opposed to its remuneration report. More than 60% of investors voted against the company’s remuneration report at the annual general meeting.

In the U.S.:

A bid by Goldman Sachs Group Inc. to settle a lawsuit over how much it pays directors was rejected by a judge who said that simply making changes in corporate governance didn’t provide enough benefit to the firm. The lawsuit charged that a stock incentive plan for executives and directors was not sufficiently disclosed. The settlement terms involved no payments to shareholders, just an agreement to hire a consultant to review the pay of outside directors and additional disclosures, including an acknowledgement that Goldman Sachs directors are among the highest paid in the country. The objections to the settlement terms came from Fordham University law professor Sean Griffith, who said that the suit had “potentially-meritorious monetary causes of action’’ that were being extinguished without proper benefits in exchange.

Annual PWC Directors Survey

The annual PWC survey of corporate board members once again shows a gap between what directors say and what they do, and between what shareholders and directors think is important.

More than 800 U.S. board directors responded to the questions, and there were meaningful increases of 7%-10% in the number of directors saying issues like health care availability, human rights, and income inequality should be critically considered when forming company strategy. With recent corporate scandals bringing national attention to corporate culture, 87% of respondents acknowledged that the tone set by the executive team contributes to problems with company culture. However, 79% pointed to the tone set by middle management as a driver for negative workplace behavior. Board members were better at identifying problems than fixing them. A remarkable 45% said that at least one of their fellow directors should not be on the board. And boards have done better in discussing cybersecurity (84%), but most have not done much to test their responsiveness (only 34% have) or even issue a written policy (only 47% have).