Corporate Governance in an era of Clawbacks, ESG, Mega-Managers, and Zombie Investors

Two expert panels came together at the Conference Center at UBS Tower on November 29th to provide insights to various aspects of board related corporate governance. The first panel, moderated by Eileen Kamerick, focused on Management and Directors. Kamerick is a current and previous board member of several financial and industrial companies and is an adjunct professor. The panel included Thames Fulton, managing director at RSR Partners (executive recruiting); Frank Jaehnert, member of the board of directors of Briggs & Stratton, Itron, Inc., and Nordson Corporation; and Todd Henderson, professor of law at the University of Chicago Law School.

Kamerick started with a question about board diversity – should investors care about diversity? Henderson believes board diversity is a top issue and gave the following example of why boards lack diversity. When adding board members it is typical to get one or two women and / or a minority on a board, and then the board stops diversifying. Boards go through a ‘we are diversified enough’ type of thinking. Boards also suffer from a bias by what traits they look for in a new board member, which is usually for a former CEO or an operating exec type skill set. The pool of women or minorities coming from this group is already small, so the odds of getting a diverse board pick is reduced. The lack of diversity in the C-suite carries forward to the board. To combat the small pool of current/former women CEO’s corporate boards should look for a skill set other than a CEO, looking at other non-corporate entities such as universities, foundation/endowments or the private equity world. While the panel was in favor of board diversification, they were against legislation for mandatory board seats for women – legislation of behavior is not usually effective.

The panel then considered the topic of executive compensation, which is under the prevue of a corporate board. How should the board determine reasonable compensation? Jaehnert advised that the alignment of executive compensation with that of the shareholders is crucial, and that compensation should not be mandated but it should be provided in a defined and appropriate manner. Henderson considered that boards and investors spend too much time on CEO pay, because CEO’s are underpaid relative to revenues.

Kamerick asked the panelists to elaborate on how to set executive compensation. The panel advised that even if peer compensation or quasi government mandated compensation is used as a guide, the compensation committee is still responsible for setting executive compensation. However, most of these committees lack the training or background that is typically required. To obtain the appropriate skill set a board should have a current or former head of HR as a board member. In practice a board is more likely to rely on the job training, gathering executive compensation skills in a disjointed manner. One area that should be considered to obtain expertise on management compensation is the private equity world, which is better suited to choose compensation packages.

Kamerick brought up claw back policies – should they be used, are they effective. The panel as a whole was in favor of claw backs for a variety of instances including fraud, and for reputational damage as a result of executive actions. The panel advised a downside of claw backs; provisions of this sort would increase CEO pay. If a CEO understands that he/she will continue to be responsible for claims against them, the CEO will mitigate that by asking for more compensation. To combat this behavior the panel suggested using disgorgement of earnings, which would work better than claw backs.

The last topic the panel discussed was that of board services. An example why board services make sense was provided; when a corporation needs financial or legal help, the corporation hires a CPA or law firm to get the needed expertise. However, when a corporation needs governance (via a board) they hire individuals who do not have the collective depth of governance knowledge required. Hiring for board services should be allowed, but is illegal in Delaware (which exclude corporations) as well as in the Investment Company Act of 1940 (which exclude investment companies). An area in which there examples of professional boards could be found in the LLC space.

The panel provided some final thoughts based on audience questions;

  • If you have been on a board for a lengthy period of time, you are probably no longer independent.
  • Search firms are not favored by boards when looking for new board members. The board will seek out people they know or have had a history with.

 

The second panel focused on topics related to investors and asset managers. The moderator was Bob Browne, CFA, executive vice president and CIO at Northern Trust. The members of this panel included Gillian Glasspoole, CFA, senior associate of Thematic Investing for the Canada Pension Plan Investment Board; James Hamilton, CFA, director at BlackRock; and Kevin Ranney, director of product strategy and development at Sustainalytics.

Browne started with a question about analysis of a corporate board governance – is good or bad governance worthy of investor analysis? Hamilton advised that as an investor engagement of a board is process oriented, meeting with the board as well as senior management. It is through these meetings where one can get a sense of if the board is adding value. Depending on the size of the corporation, some education of the board regarding governance can occur. Larger cap companies have ESG processes in place, whereas the middle and small cap corporations are more open to having institutional investors provide guidance on ESG good practices.

Browne then asked the panel to consider difference between corporate governance in Europe versus the United States. Europe is more tuned in to ESG and looks to meet or exceed international standards. In Europe board diversity and executive compensation are linked to ESG targets. From the asset owner perspective Europeans are more inclined to think about ESG and have specific goals to address them. However, Europeans do not try to link alpha to ESG as much as it is done in the United States and Europe considers ESG value unto itself, without the need to have a positive correlation to alpha.

Another cultural board difference between Europe and the United States is the holding of CEO and chairman role by the same person (common in the United States, frowned upon in Europe). Hamilton considered that holding the CEO and chairman position is an acceptable practice, but other strong independent voices are needed in the boardroom to offset that dynamic.

The panel closed the program with a discussion regarding board transparency. How does an investor know if a board is doing the job they were hired for, and they are acting in the best interest of stakeholders? The panel noted in practice it is hard to determine if a board is engaged, but there are ways to get an overall idea. Do all the board members go to all committee meetings, do they have onsite visits to offices other than the headquarters? Learn to ask the correct questions and then you will uncover issues that will impact the value of the company.

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