Governance Focus May Go Too Far
This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.

“Nothing focuses the mind like a good hanging.” This was the reaction by some attendees of the recent Directorship Boardroom Forum to the 24-year prison sentence handed down to Enron’s Jeff Skilling. Though in some quarters the punishment seems excessive, speaker Jim Cramer of TheStreet.com expressed delight at the penalty, which will send Mr. Skilling to jail “hopefully for the rest of his life.”
Has animosity toward big business ever been as vitriolic? Outrage at the seeming unending series of corporate misdeeds and scandals is in the process of having a profound impact on how companies are managed, for better or worse. Reviewing the various presentations at the forum, one concludes that not all these changes will be for the good.
Mr. Cramer led off the sessions by noting that instead of taking a nosedive like most stocks hit with accounting or governance hiccups, shares of companies accused of options backdating have actually done quite well. Why is this scandal different? In his view, shareholders view the backdating of options as a compensation issue, not an accounting issue, and therefore less heinous.
Also, shareholders think that managements engaged in the practice to profit from expected future gains in companies’ share prices. Ergo, the practice has been read as an unconventional insider endorsement of the stock.
Mr. Cramer was disapproving of the practice, and also of the issuance of earnings guidance, which he described as a “sucker’s game,” and a “big show just for the hedge funds.” He thinks it is impossible to give honest guidance, and therefore recommends abandoning the practice.
He is not charitable to hedge funds, though he ran one for several years. Admitting that hedge fund activists are increasingly visible in board rooms, Mr. Cramer describes them as being “out for a quick buck — that’s in their charter. They are forces of negativity, and only out for themselves.”
Notwithstanding Mr. Cramer’s dismissive comments, hedge fund activists are creating waves. They are tapping into a backlash against corporate greed and wrongdoing which has galvanized shareholders of all kinds. The ramifications are broad. Come spring, changes in the SEC’s reporting requirements will mean that shareholders will get a detailed look at all aspects of executive compensation — including previously hard to find numbers on deferred compensation and pension plans, and perks like use of the company jet.
Increased adoption of so-called “majority voting” means that board members must be elected by a majority of shareholders. Historically it was practically impossible for shareholders to knock someone off a board, since such elections are normally without competition. Majority voting will change that, and allow shareholders to remove a director by simply withholding votes.
Further change comes from the New York Stock Exchange, which has just ruled that brokers will no longer be allowed to vote clients’ proxies in the election of directors. This decision is raising the specter of companies having to scramble to secure a quorum vote, since individual shareholders frequently do not vote their shares. This also raises concerns that special interest groups such as unions or the AARP will begin to tap their extensive memberships to influence corporate policymaking.
One of the Forum speakers was Francis Coleman, executive vice president of Christian Brothers Investment Services. His group represents 120 faithbased organizations, and tries to influence companies to behave in a socially responsible manner. He says that corporations are much more responsive today than when the group started up in the late 1990s. He feels that their openness has stemmed from the group’s ability to convince managements that “social issues have a positive business outcome.”
Maybe, or it may be that corporations are running scared. Managements are all too aware of “reputational risk.” The Internet has rendered all brands, and reputations, fragile. A company or an executive can be trashed overnight through salacious commentary on a blog, and any large organization can begin a protest online virtually instantaneously.
Truly, for corporations, these are treacherous times. Executive compensation, the makeup and remuneration of the board, “poison pill” takeover defenses — all these issues are being analyzed and impacted by shareholder groups like ISI, which will soon be advising individuals as well as institutions on proxy voting. Moreover, individual board members and executives are being required to attest to the integrity of financial statements and processes that they really are not in a position to judge, and the penalties for error are extreme.
Could this democratization of corporate management go too far? In an effort to combat the extremes of gluttony and self-serving behavior, are the regulators going to err on the other side?
One possible negative outcome of these trends is the increasing difficulty of finding appropriate board members. Compensation for board members rose 14% last year, compared to 7% for CEOs, and still there is a shortage of qualified candidates.
For instance, most CEOs would like to have other chief executives on their boards. They figure that these individuals bring knowledge and skills that may be helpful in making real-life business decisions. The increased personal liability and time required for board service is leading some companies to restrict the number of boards that CEOs are allowed to serve on. In any case, most CEOs are not as keen to take on extra responsibilities.
Another downside is the facilitating of hedge fund activists, who typically do not have the ordinary shareholder or company employee uppermost in their hearts. This is a serious consideration as takeover defenses are dismantled and as ordinary shareholders are given the power to implement change while also being increasingly susceptible to influence. Short-termism is increasingly viewed as a negative influence on business decision-making. There is no group more enamored of the short term than the hedge fund community.
Will seasoned, successful managers decide that the public distrust and scrutiny attendant to the CEO role is simply not worth it? Doubtful. CEOs are still highly paid and most probably enjoy being at the top of the heap. However, there is a steady stream of talented individuals being lured away by hedge funds or private equity firms. One of the most recent examples is David Calhoun, one of Jeffrey Immelt’s close associates at GE, who went to work for private equity giant KKR.
Leaving the limelight can be rather peaceful.