The subtitle of Money for Nothing
John Gillespie and David Zweig spend the first half of the book bashing on the easy targets: Countrywide, Lehman Brothers, Tyco, Fannie Mae, GM, Chesapeake, and AIG.
The role of the board of directors
The board of directors of a corporation is supposed to oversee senior management, approve key strategic decisions and nominate directors for appointment by shareholders. That part is the legal framework.
Strong governance would have the board members contribute their business knowledge and long-term vision for the company to help guide the executives in running the business operations. They should be a check on executive power and act as a watchdog for long-term shareholder value.
For some companies, the board is merely a tool to lend legitimacy to the fiction that shareholders’ interests are being taken into consideration.
Testing board governance
How do you measure or identify poor corporate boards? One measuring stick is executive compensation. It does make sense that an over-compensated CEOs should be an indication that the board is not willing to stand up to the CEO. That may also lead you to conclude they are not paying attention to succession, ethics or risk management. The authors don’t reference any studies or empirical evidence that their conclusion is correction.
Board failure
Clearly shareholders should want a board of directors that contribute to the leadership of the corporation. They should not want simple rubber stamps for approving the decisions made by the CEOs.
A director who speaks out risks being ignored or being thrown off the board in the next election cycle. After all, shareholders have little or no input on who gets nominated to be a director.
Chesapeake
One example in the book is Chesapeake Energy Corp. They cite the work of Michelle Leder of Footnoted in digging through the company’s filings to discover excessive executive compensation and naming the worst footnote of 2009. In addition to his excessive salary as the company was under-performing, the company purchased CEO Aubrey McClendon’s antique map collection for $12.1 million (that was $8 million over its valuation).
Separating CEO and Chairman
Is it the structure of the board? One change that makes a lot of sense is splitting the Chairman and CEO positions. The authors cited a study by Lucian Bebchuk and Jesse Friedin in Pay without Performance
Let the CEO run the company with the board of directors as the CEO’s boss. Let the chairman run the board of directors. They are different tasks with different needs.
How does excessive CEO compensation happen?
Zweig and Gillespie mention one reason when they discuss a conversation they have with Dennis Kozlowski, the imprisoned former CEO of Tyco. Kozlowski said he thought his compensation was justified in relation to what hedge fund managers were getting for creating considerably less value.
The second reason is one I like to call the Lake Wobegon Effect. It’s hard for a board to say that a CEO is below average without firing him. If you set the pay and compensation to be below average, then you are making a negative statement. As a result most CEO pay gets set at the average or above average. That has the effect of moving the average upward when next year’s round of compensation consultants look at average salaries.
An Economic Policy Institute study showed that CEO compensation has risen to become about 10% of all corporate profits. That’s nearly double the level it was in the min-1990s. (See The State of Working America)
How much does the board affect performance?
It’s easy to attack the failures of Lehman, Bear Stearns and Merrill Lynch. If you are going to blame some of the failure on their boards, shouldn’t there be some credit given to the boards of Goldman Sachs and Morgan Stanley? Goldman and Morgan survived and the others didn’t. Perhaps the causation is not as strong at the authors think.
The authors criticize the board of Exxon-Mobil. I agree with the criticism. On the other hand, the company has experience remarkable success as one of the world’s biggest companies.
(I do own stock in Exxon and Goldman.)
The gatekeepers
The authors don’t just stop at the board. They have plenty of harsh words for the auditors, lawyers, compensation consultants and other professionals hired by boards. These gatekeepers have a “vested interest in preventing the boat from rocking.”
They have a rant worthy of Francine McKenna on auditors:
“Accountants and auditors in America seem to have spent the last century dodging five major terrors: regulation, financial liability, legal liability, the imposition of uniform accounting practices, and offending current and future corporate customers by making audit rules and processes more rigorous and accurate.”
What to do?
For retail investors I think the answer is very easy. Sell the stock and buy stock in a different company. Its a bigger issue for institutional investors. Their ownership interest may be so large that selling their position would bring down the share price even further resulting in an even bigger loss.
After 200+ pages of pointing out board failures the authors turn to a chapter full of solutions and ways to fix boards. If you are a student of corporate governance you’re not going to find anything particularly new or innovative in the author’s proposed solutions.
The real question is how to get them implemented. As the authors tell throughout the book, it’s not in the short-term interests of the board or senior executives to implement these changes. It will be up to the exchanges, regulators and big investors.
Thanks
I want to thank the book publisher for providing a review copy of the book and Jerod Morris of Corporate Compliance Insights for directing it my way.