Warren Buffett and his company Berkshire Hathaway Inc. are expected to maintain their $5 billion investment in Goldman Sachs Group Inc. until at least 2011, according Reuters. Buffett acquired preferred shares and warrants to buy common stock at $115 per share, last September, when Lehman Brothers Holdings Inc. collapsed. Common stock shares in Goldman Sachs declined to $47.44 by November, but have recovered to $143.09 as of June 18.

Goldman Sachs recently repaid $10 billion of TARP funds to the US government and expects 2009 profits and bonuses to reach a new high, according to the Guardian. Buffett’s presence at the investment bank is not felt as much as the government’s because of Buffet’s hands-off investment style. Critics questioned the famed investor’s decision at the time as the stock markets worldwide continued record sell-offs, but present market conditions and recent rallies have proven Buffet right, so far.

Goldman Sachs CEO, Lloyd Blankfein, and other executives at the investment firm have agreed not sell more than 10% their shares until October 2011 when Buffet can convert his warrants into common stock.

“I would like the commission to act with respect to proxy access as soon as it can,” said Walter, who predicted an SEC revision of proxy rules this year. Walter is a Democrat who had held the commissioner seat since January 2008.

The traditional means of nominating directors—only following a successful proxy battle—has long been maligned by shareholder activists who protest that such a system is too restrictive on minority company owners. Corporate directors generally support the existing system, as it largely prevents activists from rocking the boat.

SEC chairman Mary Schapiro has also made clear her stance on the issue, having told Congress that U.S. regulators should follow the lead set by other countries that allow smaller shareholders access to the proxy document.

Monks, a lawyer, author, and founder of Institutional Shareholder Services (now RiskMetrics Group) and The Corporate Library, bemoans what he sees as a general failure on the part of institutional shareholders to exercise their fiduciary duties and ownership rights as a check on management. He is also critical of the role of boards to provide oversight and calls for a revitalization of the ownership duties of institutional investors, particularly mutual funds.

“I am as concerned as millions of other investors as I watch the deterioration of a great company,” wrote Greenberg, who built AIG into the world’s largest insurer in his nearly 40 years as chief executives now heads Starr International Co., AIG’s largest shareholder.

The insurance behometh last week reported its worst results in 40 years. Over the last twelve months, shareholders of AIG have lost $80 billion in the aggregate.

“Several top shareholders of AIG have called me expressing deep concern about the persistent and seemingly endless destruction of value at AIG.  They, and I, are deeply distressed by the excessive loss of value,” Greenberg wrote.

Greenberg reasons that instead of hosting its annual meeting, board members need to take time to digest the losses and strategize on their response. “For this reason and others, a postponement of this week’s annual meeting should be considered so that all shareholders can give careful thought to how best to move AIG forward.”
 

Carl Icahn, after a recent activist campagin targeting Motorola, pleaded with institutional investors to give him support in his efforts to stir change at American corporations, according to TheDeal.com.

His plea asked investors to oppose anti-takeover provisions such as poison pills and staggered boards at companies. “It’s a shame that you people who have key votes don’t undestand how bad the situation is,” said Icahn. “It’s really pathetic out there because you have CEOs who earn 400 times what the agerage worker earns. You hate to say it, but it’s really stealing with all these boondoggles going out there.” 

In a discussion with reporters after his remarks, Icahn said he was upset that the Securities and Exchange Commission hasn’t approved a rule that would allow investors to nominate one or two candidates on company ballots.

Icahn’s efforts in a proxy fight at Motorola come only months after he lost a campaign last year to elect a director candidate to the company’s board. The drive, though, fell short by a few hundred-million votes.

Meanwhile, the activist this week also said he is starting a blog to discuss ideas on corporate governance, a topic on which he has strong opinions.

The blog, www.icahnreports.com, will be a forum where readers can comment on or present ideas and Icahn, who has a long history of stirring for change at companies, will respond.

“This country is losing its economic hegemony,” Icahn said in a corporate governance conference in New York recently, according to Reuters. “I want to see who is interested in this. I really think there’s a lot to do.”

AIG and Greenberg, 82 years old,have been dueling ever since his departure. The two sides have lawsuits pendingagainst each other relating to stewardship of the company. The Journal reportsthat investors are jittery. AIG shares fell more than eight percent in middaytrading one day last month, before largely bouncing back. Much of theirnervousness stems from potential exposure to the subprime mortgage market. AIGis scheduled to report third-quarter earnings tomorrow.

Greenberg made his statements in a 13D filing to the Securities and Exchange Commission last week. Such a filing doesn’t commit a filer to a specific action.

Shareholders of Applebee’sInternational and MidWest Air Group have recently approved ownership changes within their respective companies.

Those at Applebee’s voted to approve IHOP Corp.’s $1.9 billion acquisition of therestaurant chaindespite differences among independent shareholder advisory firms on whether torecommend the deal. Applebee’s said in a statement that votes in favor of thedeal represented more than 70 percent of its common shares.

Applebee’s, hit hard by weakenedconsumer spending and competition from rival bar-and-grill chains, in Julyagreed to be bought IHOP for $25.50 a share plus debt. The company saidyesterday the deal is expected to close by Nov. 29.

In February, following months ofbehind-the-scenes maneuvering and a brief proxy fight with activist shareholderRichard Breeden, Applebee’s said it was considering its strategic options,including a possible sale. In recent weeks, independent advisory firms,Institutional Shareholder Services and Glass Lewis & Co., recommended thatApplebee’s shareholders vote in favor of the proposed sale. Rival firms, ProxyGovernance and Egan-Jones Proxy Services, had advised Applebee’s shareholdersto oppose the deal.

IHOP CEO Julia Stewart, a formerApplebee’s president, said on a conference call last week that the twocompanies were already working on the integration process.  On Monday, Applebee’s said itsyear-to-date sales through September in restaurants open for at least a yearwere down 1.8 percent.

Meanwhile, shareholders of MidWest Air approved a merger agreement that would provide for the acquisition of the company by MidWest Air Partners LLC, an affiliate of TPG Capital LP, formerly Texas Pacific Group. 

As part of the agreement, each outstanding share of MidWest’s common stock will be converted into the right to receive $17 per share in cash.

The transaction is expected to culminate in the fourth quarter of this year, and is subject to customary conditions inclduing anti-trust approvals. 

]]> http://www.directorship.com/shareholders-at-two-major-companies-approve-ownership-changes/feed/ 0 http://www.directorship.com/ceos-likely-to-get-higher-pay-with-comp-consultant-study-finds/ http://www.directorship.com/ceos-likely-to-get-higher-pay-with-comp-consultant-study-finds/#comments Thu, 01 Jan 1970 00:00:00 +0000 Joseph McCafferty http://www.directorship.com/?p=3965 Companies using compensation consultants have a tendency topay their CEOs more, though the pay levels do not seem correlate toincreased shareholder return, a new study by The Corporate Library finds.

The Effect of Compensation Consultants: A Study of MarketShare and Compensation Policy Advice, was released by the Corporate Librarylast week, and focuses on two parts of the effect of compensation consultants:

• The typical pay practices of companies that use particular consultants
• The relationship between the use of a particular consultant by a company and the company’s total shareholder return.

Among other highlights, the study measured CEO base salary.When compared to the median of peers, base salary ranged significantly depending onthe compensation consultant used. Additionally, the report shows that TowersPerrin is the top compensation consultant with a grip on 29 percent of themarket share and employed by more than 400 companies surveyed by the CorporateLibrary.  Coming in second was MercerHuman Resource Consulting, which holds 22 percent market share, and inthird, Hewitt Associates.

“Our findings indicate that compensation consultants areassociated with companies that pay at levels higher than the market median. Thesehigher levels of pay are in general not associated with higher levels ofshareholder return.” — Alexandra Higgins, TheCorporate Library.

Investors have seen compensation consultants play anincreasing role in helping boards set and determine executive and board pay,and the increase in the use of consultants has much to do with increaseddemands for compensation committees to align executive pay with shareholderinterests and comply with new disclosure requirements set for the by theSecurities and Exchange Commission.

“Our findings do indicate that compensation consultants areassociated with companies that pay at levels higher than the market median,”said Alexandra Higgins, author of the report and research associate at theCorporate Library in a statement.  “Further, thesehigher levels of pay are in general not associated with higher levels ofshareholder return.”

The report is available for sale to the general public at theCorporate Library’s website.

]]> http://www.directorship.com/ceos-likely-to-get-higher-pay-with-comp-consultant-study-finds/feed/ 0 http://www.directorship.com/nazareth-cautions-against-moving-forward-with-sec-vote-on-proxy-access-proposals/ http://www.directorship.com/nazareth-cautions-against-moving-forward-with-sec-vote-on-proxy-access-proposals/#comments Thu, 01 Jan 1970 00:00:00 +0000 Joseph McCafferty http://www.directorship.com/?p=3170 Securities and Exchange Commissioner Annette Nazareth, the only remaining Democrat on the Commission, has joined a growing chorus of voices who have said it would be unwise for the SEC to decide whether or not to allow shareholders agreater say in the compositions of boards of directors, Jeremy Grant ofFinancial Times reported today.

The issue on proxy access has evolved into one of the mostcontentious in recent years for the SEC, and the Commission has floated two opposingproposals on whether or not shareholders should be allowed to proposeamendments to a certain company’s bylaws, subsequently allowing them to choosewho could be elected to the board.

One of the two proposals would allow proxy access if ashareholder has held five percent or more of a company’s shares for more than12 months, while the other clarifies that the SEC could allow companies toexclude such bylaw amendments, FT reported.

In opposing the move to vote, Nazareth joins agroup who share her concerns that include Congressman Barney Frank (D-MA). Frank, chair of the House Financial Services Committee, recently said it would be unwise for the SEC to decide on shareholder rightswith limited democratic presence on the five-commissioner panel after RoelCampos resigned last month; Nazareth shortly after announced her plans tofollow suit, though she has yet to determine when.  Both have voted in favor of the five-percentproposal.

“Under the circumstances, this seems a particularlyinopportune time for the commission to be considering issues of this magnitudeand divisiveness,” Nazarethtold a meeting of the International Corporate Governance Network, according toFT.

Regardless, SEC Chairman Christopher Cox said last week thathe has every intention of moving forward, as  the panel’s current Republican-dominant statusis independent of whether or not a vote can be made, and would like to see adecision made in time for the next proxy season.

“Negativerating actions are more likely when share repurchase programs reflect asignificant shift in prior financial policies,” said Moody’s Senior VicePresident Michael Levesque. “All the negative rating actions in our studyresulted from repurchases that increased debt enough to move the needle onleverage ratios, debt-service ratios or other metrics to a lower rating.”

Severalfactors can help offset the potential for negative rating actions.”Funding repurchases with excess cash on the balance sheet, operating cashflow, or asset sales, can alleviate the need for incremental debt, easingdownward rating pressure,” said Mell Matlow, Moody’s associate analyst andlead author of the report.

Moody’scited IBM’s $15 billion buyback plan announced in April as an example; itdidn’t result in a downgrade, even though it was funded with $10 billion worthof debt.

All 44negative rating actions in Moody’s study resulted from buybacks that “increaseddebt enough to move the needle on leveraged ratios, debt-service ratios andother metrics,” the agency said.

Additionally,of the 100 transactions studied, eight cases involved an asset sale to fund ashare buyback. Of those eight cases, one transaction led to an outlook changeto negative and two led to rating downgrades. Moody’s said that when assetsales are used to fund share buybacks, rating actions would depend in part onwhether the assets sold were profitable, as well as on their size insofar asthey served as collateral for the company’s debt.

Overall,downgrades linked to share buybacks often occur when Moody’s believes a programresults in a significant shift in financial policy, an erosion of creditmetrics that may take several years to restore or a significant loss ofcollateral value or future cash flow. Moody’s also noted that buyback programsstructured over several years are less likely to lead to a rating action.

The board and management team are assessing a variety ofoptions to improve business and the company’s competitive position, which mayinclude possible organizational and operational improvements, capitalization,or other transactions.

The clothing retailer has been islocked in a boardroom tussle over the ouster of Ezra Dabah, who resigned as CEOin September but remains on the board. He claims that a small group of the board engaged in a “power play” to oust him.

The board has yet to set a specific timeline for thecompletion of the review, and there is no assurance that the review processwill result in any changes to the company’s current organizational oroperational structure, or lead to any transaction in particular. 

“The board of directors and management team are focused onstrengthening the organization and positioning the company to take advantage oflong-term opportunities through its Children’s Place and Disney Store brands,”Children’s Place interim CEO Chuck Crovitz said in a statement.  “We believe it is in the best interest of thecompany, our shareholders, and employees to initiate a comprehensive review ofstrategic alternatives for the business and to evaluate a variety of differentoptions for enhancing shareholder value.”

Currently, directors at the company are elected by class to staggered three-year terms.  If the amendment is approved, declassification will be phased in over a three-year period, and beginning with the 2011 annual meeting, directors will be elected each year for one-year terms.

“Our board of directors has reviewed these issues carefully and decided to begin instituting this change,” said John Faraci, International Paper chairman and CEO, in a recent statement.  “Over the past several years, the company considered the issue of annual director elections, and with the transformation plan well underway, we believe the timing is right to move forward.”

In late September, a research report from Moody’s indicated that the paper and forestry products industry lagged other industries in corporate governance matters. The report found that companies in the industry tended to have anti-takeover defenses, entrenched boards and management teams, and other indicators for poor governance.

]]> http://www.directorship.com/international-paper-dumps-staggered-board-elections/feed/ 0 http://www.directorship.com/kellywood-rejects-unsolicited-proposal/ http://www.directorship.com/kellywood-rejects-unsolicited-proposal/#comments Thu, 01 Jan 1970 00:00:00 +0000 Joseph McCafferty http://www.directorship.com/?p=2691 Kellywood Company, a marketer of apparel and consumer soft goods,announced that its board unanimously determined that an unsolicitedproposal by Sun Capital Securities Group, LLC, is not in the bestlong-term interest of the company and its shareholders.

According to the article, investors have said the sale ofPetroChina is a sign that some Chinese stocks may be overvalued, now might bethe right time to cash in by getting out. 

Social activists, however, have been pushing investorsto sell their shares in the company, and see a small victory in Buffett’s move,as government-controlled PetroChina invests heavily in Sudan and buys a large portion of the country’soil exports, and the money is being used by Khartoumto sponsor widespread genocide in Darfur.

“There are a lot of people paying attention to what he(Buffett) is doing and watching the trajectory of his move,” Andrew Foster,director of research at Matthews China Fund, told the  Journal.  “As investors, we’re allwrestling with the fact that it’s difficult to justify current valuations in China, eventhough there has been a lot of fundamental, macroeconomic progress there.”

As announced on May 20, Hologic and Cytyc, a diagnostic and medical device company that designs and manufactures innovative surgical products, entered into an agreement to combine the two companies in a cash and stock transaction under consideration of about $6.2 million that is expected to close by the middle of the month.

Cytyc’s proxy materials, which stockholders are encouraged to read in their entirety, provide a detailed discussion of the process that led to the proposed merger, and the reasons behind the unanimous recommendation of Cytyc’s board that stockholders vote in favor of the merger.

Few issues related to business management are as insidious as the market’s obsession with short-term results. Earlier this year, the U.S. Chamber of Commerce convened an independent, bipartisan commission on the regulation of U.S. capital markets in the 21st century. The commission’s key focus was on quarterly earnings projections as a causal factor for managements’ short-term behavior in running their companies. Specifically, the commission recommended that companies “stop issuing earnings guidance or alternatively, move away from quarterly earnings guidance with one earnings-per-share (EPS) number to annual guidance with a range of EPS estimates.”

In 2006, the CFA Centre for Financial Market Integrity and the Business Roundtable Institute for Corporate Ethics published a report called, “Breaking the Short-Term Cycle,” which took a broader view of the causes for short-term behavior. While pointing the finger at quarterly earnings guidance, the panel of participants, which included thought leaders from corporate issuers, analysts, and investors, confirmed what academic research suggests: “The obsession with short-term results by investors, asset management firms, and corporate managers collectively leads to the unintended consequences of destroying long-term value, decreasing market efficiency, reducing investment returns, and impeding efforts to strengthen corporate governance.”

What is often left out of the short-termism discussion is the effect of short-term compensation incentives for asset managers and corporate management. Consequently, the report recommends that compensation should be structured to achieve long-term strategic and value-creation goals.

Additionally, the report calls for leadership in shifting the focus to long-term value creation. Clearly, corporate boards of directors have an opportunity to play a significant role in providing this leadership to reverse the market’s myopia. They can achieve this by structuring executive compensation to focus on long-term goals and by providing strategic guidance to management that results in long-term value creation.

Just Say No

Is there a relationship between quarterly financial guidance and short-term behavior? A National Bureau of Economic Research survey of 401 financial executives found that 80 percent said they would decrease spending on research and development, advertising, maintenance, and hiring in order to meet short-term earnings targets and 55 percent said they would delay new projects, even if it meant sacrificing longer-term value creation.

Even more shocking was a Duke University survey of CFOs that found that, “nearly 90 percent of respondents admit that business decisions are often based on tenure considerations. That is, managers don’t develop strategies for the long term because they don’t expect to be around to see them reach fruition.”

A June 2007 survey of earnings guidance practices by the National Investor Relations Institute found that 71 percent of respondents provide financial performance measurements such as EPS, revenue, cash flow, and other quantifiable measures. Additionally, 51 percent provide earnings guidance, down from 66 percent in 2006. Consistent with the trend found in the 2006 survey, twice as many companies that are providing earnings guidance are doing so on an annualized basis rather than quarterly. The survey found that most companies that provide financial guidance do so to ensure that the sell-side consensus estimate is closely aligned with that of the company and achieves reasonable expectations from sell-side analysts.

The positive side of providing some form of guidance—financial or non-financial—is that it is a means of maintaining communication with the investment community. The negative side of financial guidance—primarily focused on earnings—is that it continues to feed the needs of the sell side to make quarterly estimates. The buy side is less focused on quarterly numbers. And, with the prospects for the future of the sell side continuing to dim, investors could see a lessening effect on short-term behavior by analysts and corporations.

Herein lies a key factor that is often missing as boards and senior management discuss whether they should continue to provide earnings guidance. The influence of the sell side is clearly waning and some even project that the it will become extinct in the foreseeable future. Why? The commissions that once supported sell-side research are rapidly declining. Firms such as Prudential have closed their sell-side research operations and Goldman Sachs only provides sell-side research to a few select clients.

The Buy Side is Coming

Meanwhile, over the past few years, buy-side firms have substantially increased their research capabilities and continue to build their sector research—once the purview of the sell side.

Add to this the emerging trend where the bulk of stock selection is being conducted by Ph.D. quantitative types, or “quants,” who use algorithms and other mathematical techniques to create baskets of stocks, such as Exchange Traded Funds (ETFs) that are electronically traded on the major exchanges. So, the emphasis on stock selection based on traditional financial analysis, is being replaced by quantitative means. Earnings projections play a minor role, at best, in this process.

These changes in market structure and how stocks are selected give corporations an opportunity to break the back of short-termism and instead focus on long-term strategies and value creation.

A new Rivel Research Group study, which sampled 243 buy-side investment professionals from some of the leading mutual, pension, and insurance funds, found that management credibility and an effective business strategy remain the leading factors for making investment decisions, outweighing such factors as earnings per share, reliable cash flow, and a strong balance sheet.

While it is clear that corporations alone cannot break the short-term cycle, in light of the above factors they now have an opportunity to play a major role. The board of directors should provide the necessary leadership to make substantive changes in management’s behavior. How can this be done?

• The board’s power to establish executive compensation philosophy and performance goals is clearly a way to demonstrate effective leadership. In developing a compensation philosophy and the resulting goals, directors would be well advised to reflect on the current emphasis on financial metrics used to measure performance. Financial metrics are key drivers of earnings guidance. Companies that have eschewed financial guidance are now focusing on non-financial guidance that is more long-term oriented. These measures are statements about market conditions, trend information, industry-specific information, and main factors that drive earnings.

• Boards should recognize that more than half of the market value of the average S&P 500 company can be attributed to non-financial factors, key among them “quality of management.” While there are no standard methods of measuring this factor, it’s like defining pornography—you know it when you see it. The board’s role in selecting the CEO, fostering the development of top-quality management, and planning for success cannot be overemphasized.

• Other non-financial factors such as research and development expenditures, sales and marketing, innovation in creating new products and services, development of human capital, corporate brand, and reputation, also play major roles in investment decision making.

• The board should work closely with senior management to create a vision for the company that focuses on long-term value creation. Emphasizing long-term goals will send a clear message to investors and asset managers that the company is serious about long-term value and will not react to short-term issues by drawing down on future commitments to meet immediate needs.

• The CEO, CFO, and the investor relations officers must effectively communicate the corporate vision and strategies leading to long-term value-creation. The board should insist on periodic perception studies of investment professionals to determine if the strategies the company is taking are resonating with Wall Street. Perception studies should also measure senior management’s credibility, integrity and leadership.

• Finally, the board and senior management should have an in-depth discussion on the company’s guidance policy. If the company provides quarterly earnings guidance, the board should know why. While there may be some value in providing annualized financial guidance using a range of estimates, the board should question the extent to which this practice continues to feed Wall Street’s appetite for near-term financial results. An alternative is to focus on the non-financial factors that lead to long-term value creation. Boards should not forget that there are more than 80 million investors in the United States and less than a million are viewing the financial news networks as the commentators get excited over which stocks hit or missed the “consensus numbers.”

So Be It

In this era of rapid and significant changes in market structure and the means for selecting which stocks will lead to sound investments, boards have an opportunity, as never before, to demonstrate strong and effective leadership by breaking the short-term cycle and getting senior management to focus on long-term value creation.

Louis M. Thompson, Jr., is a managing director at Kalorama Partners, a global business consulting firm founded in 2003 by former Securities and Exchange Commission Chairman Harvey L. Pitt.

Most baby boomers would recognize my old-school, black and white, pool-hall inspired, plastic oracle. Busters and Gen-X’ers might know it better by the numerous online versions that have sprung up.

What does this icon of pop culture know about corporate governance? Well, for one thing, the soothsaying, 20-sided, floating die—an icosahedron for all you geometry geeks—graphically represents “constructive engagement,” the dominant trend on the current governance scene.

Ten of the twenty possible answers produced by inverting the orb are variations of “yes.” Five are variations of “no.” That’s a rough approximation of the success rate of shareholders in their interactions with directors these days. Consider the following fun facts.

• Nearly two-thirds of the firms in the S&P 500 now use enhanced rules—either a plurality standard with a director-resignation policy or a full majority vote standard—for board elections.

• Dissident investors met or exceeded their goals—board seats, value-enhancing moves, or both—in more than one half of 2007’s threatened or live proxy fights.

• Less than half of large U.S. companies continue to maintain staggered board terms and poison pills.

• Nearly a quarter of the 1,100-plus shareholder proposals were withdrawn during 2007.

Magic 8 Ball (M8B)’s remaining five possible answers are non-committal, vague, or ambiguous. In other words, M8B is the perfect tool to predict the future course of actions in Washington, D.C. For better or worse, the U.S. Congress, the Securities and Exchange Commission, and the White House look primed to take over driving the bus on most of the big-ticket issues—including proxy access and “Say on Pay”—on the governance highway.

With this prologue, let’s ask, flip, and read.

Will Majority Threshold Voting (MTV) continue to spread? M8B says: “Signs point to yes.”

One sign is the fork protruding from plain-vanilla plurality voting in uncontested boardroom elections. Majority voting jumped from rare to routine over the past two years with 400-plus firms, including 64 percent of the S&P 500 firms (according to Neal, Gerber & Eisenberg partner Claudia Allen), now using enhanced director-voting rules. The MTV movement gained momentum this proxy season as proponents withdrew more than half of the proposals offered on the topic after directors agreed to adopt new bylaw or charter provisions.

How far has the needle moved on majority voting? The staid Ohio business community joined with labor union pension funds to prod that state’s legislature to tweak state law to allow Buckeye firms to opt into majority rules in uncontested boardroom elections.

In just a few short years, look for Ohio, Delaware, and other leading corporate domiciles to follow North Dakota’s lead by making MTV the default standard in boardroom elections.

Will shareholders use the MTV tool to turn out board nominees in significant numbers? M8B says: “My reply is no.”

When the SEC approves the New York Stock Exchange’s proposed rule change that would eliminate discretionary voting of uninstructed voting positions by brokers in uncontested board elections, nominees will lose their traditional 5 to 25 percent head start. Given the significant number of current “no” votes of 35 percent or more, MTV-driven director resignation offers will become commonplace.

It’s doubtful, however, that such MTV policy triggers will cause a massive exodus from boardrooms. The business community’s gloomy prophesies of an MTV-fueled boardroom “reign of terror” haven’t materialized. The first triggering of a modern MTV policy this year (at Gen-Probe) didn’t result in a shareholder mob screaming “off with her head.” Instead, the directors reached out to investors and dealt with the root cause (poor attendance, in this case) of the high “no” vote. Unless boardroom backsliding occurs, the issue appears settled.

Look for similar low-key dialogues to follow most tripping of MTV wires in the future. Also expect to watch directors reach out to investors and their advisers to cure such problematic issues prior to the annual meeting.

If boards remain opposed to access, will Washington intervene and allow shareholders to push for access rights at annual meetings? M8B says: “As I see it, yes.”

The fate of proxy access is back in the SEC’s hands. SEC Chairman Christopher Cox made it appear in July that the “S” in the Commission’s name stands for “schizophrenia” when he offered his serial support to two contradictory rule-change proposals at an open SEC meeting. (See “Washington Update” page 6.)

Will “say on pay” become the common practice in the United States? M8B says: “Better not tell you now.”

Say on Pay (SOP)—which calls for advisory votes on executive compensation at annual meetings modeled on current practices in the United Kingdom and Australia—broke from the pack of pay-related reforms in 2007. The second-time proxy campaign on the topic produced more than 60 shareholder proposals and majority votes for five of them—at Blockbuster, Ingersoll-Rand, Motorola, Valero Energy, and Verizon Communications.

Despite this stellar showing at the ballot box, Aflac remains the lone early corporate adopter of SOP. U.S. board members still don’t show great affection for the reform.

Outside of the United States, executive and board members appear quite comfortable with investor input on remuneration. A recent poll of more than 2,500 global executives and directors by consultant McKinsey & Co. found high levels of support for boosting shareholders’ ability to monitor pay practices. More than two-thirds of the global respondents supported giving shareholders more say on pay. Thirty-eight percent of the corporate audience favored a nonbinding advisory vote on pay. A nearly equal number (35 percent) of execs and board members would vest shareholders with power to veto executive-pay deals. The lion’s share (60 percent) of those who favored a bigger role for shareholders want such oversight focused on the metrics used to assess executive performance.

Will Congress act if Corporate America doesn’t take steps to adopt SOP? M8B says: “Yes.”

Nature abhors a vacuum. Washington loves one. A July Harris/Financial Times poll of U.S. adults found that 77 percent believe senior executives are “overpaid.” That’s nearly 8 out of every 10 possible voters. A drill-down into the poll numbers shows that this “overpaid” mindset cuts across lines of gender, geography, and income. Women, older persons and those with higher incomes—three groups with higher than average voter turnouts on election day—were most likely to say U.S. executives make too much. Unlike strong majorities of the respondents in the United Kingdom, France, Italy, and Spain, however, U.S. respondents don’t favor pay caps. Only 33 percent of the U.S. respondents favored government-set pay caps.

It’s not just envy. Nearly two-thirds of the respondents indicated that they either do not admire corporate leadership (33 percent) or admire them only somewhat (33 percent).

Will executive pay packages look different in five years? M8B says: “It is decidedly so.”

CEO pay will be higher in five years than it is today. The currency used to deliver such compensation, however, will be vastly different. Perks will be a thing of the past. (Yes, that includes every CEO’s favorite goodie: personal use of corporate aircraft.) Severance, deferred compensation, and supplemental retirement plans will be capped (by legislation) or zapped (by shareholder activism). Long-term contracts with guaranteed payouts will be few and far between. Plain-vanilla options and time-lapsing restricted stock will be in short supply. Instead, compensation will consist of a steady diet of performance-based pay.

Will hedge funds continue to play a significant role in corporate governance? M8B says: “It is certain.”

Hedge-fund managers are the new face of investor activism. They now account for the lion’s share of proxy battles and contested solicitations against management-proposed transactions.

Short of a massive scandal, hedge funds will likely continue to attract more dollars from pension funds and other mainstream institutions.

Despite these investments, shareholders remain ambivalent about the role played by hedge-fund activists in the marketplace. Respondents to Institutional Shareholder Services’ annual policy survey were split down the middle, with 41 percent saying hedge-fund activism has helped create long-term value and 39 percent saying it has not.

Votes at the ballot box aren’t as close. The activist hedge fund run by former SEC Chairman Richard Breeden, for example, recently won three seats on the board of H&R Block with a landslide, four-to-one margin of victory at the ballot box (See “Postings” page 78).

Will the typical board look different in five years? M8B says: “You may rely on it.”

Look for boards in 60 months to be, on average, slightly larger, somewhat more independent, and much more diverse (especially along gender lines) than those existing today.

All directors will stand for election at each meeting subject to majority vote rules. Boards, following Pfizer’s lead, will facilitate regular confabs between institutional investors and independent directors. Director evaluations will be the norm, not the exception.

More boards will feature split CEO and chairman positions, but such separation will simply reflect higher CEO turnover levels. When CEO and chairman titles are combined, lead directors will serve as the primary (make that universal) mechanism for providing independent leadership in the boardroom.

There will be fewer committees (look for executive and finance panels to bite the dusts), but the remaining panels will meet more often.

Boardroom pay will continue to rise, but options, director perks, and charitable award programs will perish. Stock ownership and retention requirements will rise and lengthen, respectively.

Will the typical director look different in five years? M8B says: “Yes–definitely.”

Look for directors to be older (retirees have already eclipsed sitting executives as the primary food group), more diverse (reflecting an expanded and less CEO-centric candidate pool), and less immersed in boardroom culture.

Look for a new class of “professional” directors to emerge. “Professional” will describe how these individuals view boardroom service—as a vocation rather than an avocation. Populating this new director class will be successful, mid- to late-career professionals who want a change of pace and new challenges. They’ll happily trade in pressure-packed 7 a.m. to 7 p.m. jobs at corporations, audit firms, law firms, consulting firms, and investment houses for full-time (read: three-to-five seats) board service. Given rising boardroom pay levels, individuals will look to replace most of their six-figure compensation packages by maintaining full dance cards.

Importantly, such individuals will owe their status as directors to the shareholders who nominate (see proxy access above) and elect them (see MTV above) rather than to their membership in the long-standing, old boys/girls club or their presence in old-line search firms’ Rolodexes. As such, these individuals’ reputations will be paramount to their continuing presence on boards. They’ll network with peers and investors. They’ll actively seek continuing education.

Patrick S. McGurn is executive vice president and special counsel at Institutional Shareholder Services, a proxy advisory firm.

Shareholder activists have responded by saying that the second proposal is so onerous it provides virtually no access at all. Two groups, the Social Investment Forum and the Interfaith Center on Corporate Responsibility, formed a lobbying campaign called Save Shareholder Rights that aims to kill the first idea and revamp the second one.

The skirmishing will intensify after October 2, when the SEC’s comment period on the two new proposals ends and Cox will have to decide whether to go ahead with one or the other. The most likely near-term outcome is a victory for the business community, which generally opposes greater access as likely to trigger costly and divisive battles over board seats. The reason: Roel Campos, one of the two Democratic commissioners who voted for the second proposal, resigned in September.

Until Campos is replaced, the most shareholder groups are likely to get is the status quo—i.e., no action on either idea, which suits business just fine. In fact, the activists will be lucky if neither proposal passes in its current form, since the first would leave shareholders with no access to proxy ballots, while the second would leave them with access few could probably use in light of its stringent rules. “I don’t see how the access proposal moves without a second Democrat on the commission,” says Michael Ryan, executive director of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness.

Still, there’s plenty of uncertainty, especially since Cox has said he wanted new access rules in place by the end of the fall, in time for the 2008 proxy season. In an apparent attempt to be bipartisan, the chairman voted for both proposals, despite their contradictory nature.

Let Bylaws be Bylaws

The conflict over board nomination procedures arose out of a federal appeals court ruling last year that invalidated a 1990 SEC policy on the issue. It allowed companies to exclude shareholder director nominations from their proxies. In response to the ruling, the SEC staff drafted the second proposal that under strict circumstances would permit bylaw changes enabling stockowner proxy access.

At the last minute, the five commissioners received the first proposal to reinstate the agency’s 1990 position. That would seem like a direct challenge to the appeals court, given that it rejected the SEC’s amicus brief last year defending this same stance. However, Paul Atkins and Kathleen Casey, the two Republican commissioners who backed the idea, argue that the courts are likely to defer to a formal rule passed by the SEC.

Either way, the first proposal helps business by making the second one look like a more radical departure from current practice—even though the shareholder groups seeking access reject it as deficient. Indeed, the second proposal, as it now stands, rankled not just the social activists who formed Save Shareholder Rights, but also more mainstream groups such as the Council of Institutional Investors (CII).

The proposal would allow bylaw changes on proxy access to be put on a company’s ballot by an ad hoc group of investors who collectively have owned a minimum of 5 percent of a company’s stock for at least a year. However, each investor involved would be required to disclose a raft of information. For starters, they’d have to file a 13G, the SEC schedule that requires all stockholders with 5 percent ownership to identify themselves and their interactions with the company.

That’s just the beginning. Each investor also would have to disclose any direct or indirect interest in any contract with the company or an affiliate, including collective bargaining, consulting, or employment agreements; pending or threatened litigation they’re involved in that regards the company; and any other “material relationship” with the company or an affiliate, such as a past employment relationship and other stipulations.

Investors also would have to detail which staffers, trustees, or board members were involved in the decision to pursue the bylaw change, how they were chosen for their jobs, and any fiduciary responsibilities they have.

Who Are You?

The logic behind all these demands is to give other stockholders information about who’s demanding bylaw changes that are likely to lead to a contested election. That could make sense, given hidden agendas that corporate raiders or others might hold. But activist shareholders think such extensive detail would scare off any potential ad hoc investor group before it was even formed.

In addition to being upset about all the paperwork involved, shareholder advocates are just as angry about the 5 percent threshold the new rule would require in the first place. The CII calculated that even if the ten largest public pension funds decided to form a bylaw change group, they wouldn’t clear the 5 percent hurdle at most companies. For example, they’d own just 3 percent of ExxonMobil. A large part of the reason involves the typical institutional investor practice of maintaining diverse portfolios, which often limits holdings to 0.5 percent of a company’s outstanding shares, according to a CII analysis.

What’s more, most shareholder resolutions come from a small number of activist investors, making it difficult to widen the circle enough to round up 5 percent. For example, just 16 pension-fund members of the CII filed 280 of the 688 governance-related resolutions in 2006, the CII analysis found, citing data from Institutional Shareholder Services.

In some sense, the wrangle over access isn’t really about who gets to nominate directors but who has to pay for the privilege. Right now, the board and management use the company’s funds to put forth their slate, points out University of Delaware governance professor Charles Elson. The activists pushing to change the system are asking “why shareholders should have to pay out of their pocket to nominate those choices,” he says. The SEC’s new proposal would allow at least some shareholders to piggyback on the corporate ballot, vastly reducing the millions they must pony up today to mount a full-blown proxy battle. Eventually, the greater access argument may prevail, but it seems unlikely to do so this fall.

In fact, he says, Home Depot board membersresponded positively when Whitworth and Relational Investors co-founderDavid H. Batchelder first called late last year to say they had bought$1 billion worth of the company’s stock but wanted the board toconsider major changes in the company’s strategy and direction. The twomen made clear in a letter to Nardelli that they were unhappy with thecompany’s performance and buttressed this with voluminous proprietaryresearch. Privately, the board itself had similar misgivings andelected to give the men a hearing.

“They have been terrific board members. Dave[Batchelder, Relational partner and Home Depot board member] has been afabulous director, and I am confident he will make significantcontributions to our company,” says Ken Langone, lead director of HomeDepot.

Whitworth has received plenty ofattention recently as a leading example of the heightened shareholderactivism spreading across corporate America. However, the formerprotege of T. Boone Pickens and Reagan campaign official says that hisapproach is highly focused on just a handful of companies. While mostcorporate boards aren’t likely to hear from Relational, it’s worthtaking a minute to hear his philosophy of unlocking shareholder valueand hear why he thinks many directors can learn from it.

Although Relational has a staffof a dozen or so analysts who scrutinize more than 1,000 companies withmarket caps of $2.5 billion or more, Whitworth is highly focused on avery specific kind of investment. He starts with companies in matureindustries that are profitable and have had dependable cash flows formany years. Of those, he’s on the lookout for ones that areunderperforming both their peers and their potential, as identified byRelational’s analysis.

There are a fair number ofcompanies that might fit this bill at any given time, Whitworth says,but even then he’s not going to invest in many of them. Some might havedeep structural issues that can’t easily be altered. “But then there’sanother set that seems to have lost their way,” says Whitworth, whofounded Relational with Batchelder in 1996 with a $200-million stakefrom the California Public Employees’ Retirement System. “Generally,the first indication is a history in the financial data of spendingmoney in a way that doesn’t get adequate returns for the investor.Sure, the company is still profitable and holds a defensible positionin its industry with good products, but the question is, how are theyspending the profits they make from that? Those are the ones we end upfocusing on.”

One of the things Whitworthsays he’s learned over the years is that almost invariably, there is acorrelation between companies that fit his investment profile and thefinding of major corporate governance problems. Usually, these come tolight in their excessive executive compensation policies— and in thecomposition of the board. By the latter he doesn’t necessarily meanwhat’s ticked off in the governance metrics of proxy advisers such asInstitutional Shareholder Services. Useful as those measures might be,to Whitworth they’re only a starting point. To see what’s really goingon at a board, Whitworth says, “takes a lot more research than mostoutside groups are willing or able to do.”

One example is SovereignBancorp, which Relational bought into in 2005. On the surface, thecompany had put in all the right board processes, earning it a 98percentile corporate governance score. But underneath lay a jumble ofrelated-party transactions and other conflicts that didn’t show up inall the official filings. According to public records and media reportsreviewed by Directorship, the lead director owned a companythat did landscaping for the bank, which, though it involved smallsums, was nonetheless undisclosed. Another director bought and soldSovereign branch offices, sometimes in private transactions. Boardmembers were paid $320,000 a year vs. $80,000, which is more typicalamong financial companies of a similar size. A good part of their paycame from bonuses triggered by management’s bonuses, which the boarditself was in charge of setting. Relational’s analyst spent threemonths pouring over Sovereign’s records and even traipsed off toPennsylvania and New Jersey to dig through court records to flesh outwhat was really happening.

Last year, after months ofwarfare with then-CEO Jay Sidhu, Whitworth finally prevailed. He joinedthe board and within six months directors tossed Sidhu overboard. “Whenwe see companies that are undervalued, it’s usually a symptom of poormanagement, poor strategic planning, and dynamics in the boardroom thataren’t working as they ought to—which is where we want to effectchange,” says Whitworth.

Indeed, he believes most of the problem at the companies he identifieslies in a deficiency at the board level. Many activists, whetherthey’re at pension funds or hedge funds, tend to complain about cozy orconflicted directors and lash out at individual board members whom theysee as derelict in their fiduciary duties to shareholders. However,Whitworth thinks that most directors want to do the right thing and aremore than prepared to be honest brokers for the company’s owners, butare blocked by management’s domination of the governance process.

Hedescribes the board dynamic at Waste Management, where he took over aschairman for three months in 1999 after allegations of dubiousaccounting and insider stock selling ahead of bad news. Right away, hehad directors coming up to him after meetings and saying: “Glad yousaid that, I’ve wanted to bring that up for a year.” Whitworth saysthat while his temptation was to say, “Well, why didn’t you?” he knewall too well that the environment did not allow independent views to beexpressed.

Many CEOsdo call on individual directors for advice, especially on a particulartopic in which they have expertise. But Whitworth’s experience is thattough questioning may also be seen as an attack on their program and onthem personally. “Of course, there has to be a line drawn betweenvigorous representation of shareholders’ and management’s role inrunning the company,” says Whitworth. “Too often, however, in aCEO-dominated boardroom, the line is drawn at just asking a crib sheetof questions. In that situation, you’re not expected or wanted to servea deeper purpose, and certainly you’re not expected to questionmanagement or call them to task.”

Whitworthargues that every boardroom in America should have at least oneresident devil’s advocate. His or her role is to constructivelychallenge management and ask provocative questions—and by doing so,alert management to any blind spots or hidden turns. He even goes sofar as to say that if one does not naturally emerge, the board shouldformally designate someone to the role. That way, when a directorspeaks up, the response is not just, “You’re not supporting us, you’rebeing disruptive, and you’re not a team player.” In fact, this isexactly the role Relational tries to play, says Whitworth. Even when itdoesn’t take an actual board seat, which is often the case with itsinvestments, Relational provides a detailed analysis to directors oftendemonstrating deficiencies in the reporting the board has routinelyseen from management.

It may seemcounterintuitive to think that boards will behave differently simplybecause one director feels free to challenge management. But Whitworththinks that breaking up the expected role can alter the entire dynamicbetween directors and management. “It really is alchemy,” he says.”It’s like a solution in a chemical lab; you add just one more elementand it changes completely and really starts bubbling.”

That’s thereaction he and Batchelder hope to precipitate at the companies theybuy into. Usually, it takes a few board meetings for other directors togain trust in them, says Whitworth. But once they see that the twoaren’t there for some social or other agenda, they quickly say, “Ifthere’s a way to improve this place, let’s do it.” Of course, thecatalytic role only works if Relational’s research and insights bringnot just fresh ideas, but the right ones.

SometimesWhitworth has missed the mark despite the measured process. One earlyinvestment, in a company called Nuevo Energy, seemed a perfectcandidate for reform. The chairman, says Whitworth, was the head of twopublic companies and also owned a private firm that sold to the publicones. Relational came on in 1997 and changed management, the board, andthe company’s strategy. But five years later, it finally pulled outwith a 70-percent loss. “We were painfully reminded that when youinvest in a company susceptible to commodity pricing volatility, youcan still lose no matter what you do,” says Whitworth.

Still,since its inception Relational has racked up a highly respectableaverage annualized net return of more than 18 percent through lastyear, double the S&P return over that period. Whitworth sees acommon thread running through most of its purchases. Most companieshave had a long period of growth, like Waste Management, Home Depot, orMattel, another Relational investment. But when the easieropportunities in their core businesses begin to diminish, managementmust decide whether and how to find new sources of growth, and that iswhere Whitworth’s analysis often finds the culprit. All too often,Whitworth believes, the CEO makes the mistake of taking money from thehighmargin core franchise and sinking it into lower-margin businesseswith illusions of higher growth. As a result, the company’s returns getdiluted.

Home Depot is a case in point. It had 22-percent returns in its retailstores, and Nardelli moved into wholesale supply where the margins werehalf as good. This is why Nardelli got such a poor reception on WallStreet, Whitworth asserts. “When the stock didn’t move after he doubledearnings, he said that shareholders didn’t understand what he wasdoing,” says Whitworth. “But they understood too well that he wasmigrating to a lower margin sector. The multiple investors will put on11-percent returns is far less than what they’ll put on 22-percentones.”

Notsurprisingly, after seeing Whitworth’s boardroom alchemy in action, hisview on Congressional efforts to force good governance is a bitcynical. “I don’t think you can truly legislate unlocking shareholdervalue. What the government does best is provide a minimum standard, ineffect saying to companies, ‘It better not get any worse than this.’”He believes that fine-tuning legislation so that it will result inoptimal business performance is a difficult, if not impossible, task.

“You justcan’t tweak the free market capital system. When it comes to disclosurein public filings, of course, I applaud those initiatives. But toventure beyond that bears the risk of serious unintended consequences.Generally, these approaches will focus on symptoms not causes; theanalogy would be like cutting off dandelion heads in your garden. Soonthey grow back and with a new vigor,” he says. Whitworth believes hisparticular approach is effective because the problems he deals with arecaptured at the root level, and that means usually getting down to thedynamics of the boards themselves.

“Thosedynamics won’t change until we change how the board thinks andoperates, and finally, until we change how we choose who sits on boardsof directors. I am no advocate of government plebiscites oradministrative labyrinths. I am just talking about marginal changesthat would make it easier for investors to nominate and elect theirtrue director leaders,” Whitworth says. “The reality is that we won’ttruly be serving shareholders properly until we have a process in placethat allows us to determine who sits on boards and provides a mechanismto remove and replace directors. The free market is the right place topolice the system.”

Whitworthclaims that the problems in most companies emanate from poor boarddynamics not the CEO. “Just as with excessive executive pay, chronicunderperformance is usually symptomatic of the problem, not the cause.”The problem with underperforming companies, according to Whitworth, isa lack of accountability in the boardroom to shareholders. “Even atHome Depot, in the case of Bob Nardelli, he did what the incentivescontractually told him to do—meaning increase revenues and increaseprofits, but without any particular view to the quality of thoseearnings. So Nardelli performed brilliantly under the incentives he wasgiven. Yes, the buck stops with the board.”

WhatWhitworth wants is a more vigorous input to the board, in both hiringand firing of company leaders, setting incentives, and making surestrategy is consistent with long-term shareholder interests. To dothis, he says, “requires a great deal of hard work, diligence, andindependent analysis to validate what management is saying orproposing. Then it takes courage to challenge strategy— and thispresumes the board has the smarts and experience and the counsel toknow when and how to challenge.”

Theseattributes are what Whitworth brings to his board of director roles,and why he claims boards actually find out his participation has suchvalue. The board sees numbers he offers that they have never seenbefore. That leads to changed behavior. “It is supposed to be a robustprocess and that is why in our board reviews, we look for truediversity that can bring to bear differing perspectives, personalities,and experience. If all a board does is ask perfunctory questions thatmanagement has already thought about, then that is merely a rubberstamp and you reap what you sow.”

Whitworthfinds definite advantages in sitting on a board rather than trying toeffect change from the outside. “Things are quite different when we siton a board versus merely try to effect change from outside the company.When we take on the fiduciary responsibility, we have to leave ourparochial interests behind. This generally means we are in for along-term process that requires patience and an appetite forsignificant direct communication in a much more deliberative format,”he says. “Just as in sports, there is a difference between being in thering and being the ringman, and if you are a board member, you are inthe ring and expected to perform.”

Just a decade ago, the Delaware courts gave a wideberth to managers and directors caught up in corporate disputes. Thiswas particularly noteworthy in the takeover arena. The theory held thatmost shareholders were simply unsophisticated investors who neededprotection from their own lack of knowledge and business acumen. At thesame time, managers were viewed as paternalistic fiduciaries wellpositioned to protect the corporation and its stockholders.

On the basis of these assumptions, the balancebetween managerial prerogative and investor control was tilted clearlytowards the managers for the better part of two decades. The Delawarecourts decided numerous cases in the 1980s and 1990s that consistentlyupheld board decisions to turn down the sale of a business to anunwanted suitor, even one that offered a significant premium over themarket price of the stock. Whether it was upholding poison pills orsimply allowing a board to “just say no” to a surprise bidder, thecourts seemed to view shareholders as unthinking children who requiredthe intervention of protective corporate parents.

Consequently, in the “go go” merger era of the’80s and ’90s, the Delaware courts rarely overturned the decisions ofcorporate management and their often rather subservient boards, evenwhen confronted with substantial shareholder objections.

All of this has now changed. One key factor hasbeen the visible acknowledgment from the judiciary that in an era oflarge, financially sophisticated institutional investors, shareholdersare perfectly capable of making informed judgments about theirholdings. This “shareholder is smart” view initially surfaced in a 2000decision involving a challenge to an anti-takeover action taken by theboard of Shorewood Packaging. The court ruled in favor of the potentialacquirer, Chesapeake Corp., finding that if shareholders are viewed assmart enough to know when to invest, they should be viewed in a similarmanner when it comes to their decision to exit the investment throughthe sale of the enterprise.

William Chandler, one of Delaware’s mostinfluential judges, set the judicial agenda again this February with astrongly worded opinion on backdating that may open the door to a floodof shareholder derivative lawsuits. Typically, the courts haven’t beenfriendly places for shareholder challenges to executive compensationpractices. But in a case involving Maxim Integrated Products, the judgeallowed the action to go forward.

His harshly worded decision signaled a new viewabout judicial faith in board decision-making: “Based on theallegations of the complaint and all reasonable inferences drawntherefrom, I am convinced that the intentional violation of ashareholder-approved stock option plan, coupled with fraudulentdisclosures regarding the directors’ purported compliance with thatplan, constitute conduct that is disloyal to the corporation and istherefore an act in bad faith.”

The message here is clear: Boards today must givedeference to shareholder views in ways that were unheard of 10 yearsago. In this new era, the Delaware courts can no longer be seen asreflexive defenders of managerial privilege. Dossier The Courts June/