Corporate Governance Matters



this book is different from other corporate governance books on the market and that it's really evidence driven the way we structured the book is around facts and evidence so what we do with each section is we start with an idea we explain how it works and what the positives and the negatives are of different approaches to governance and then we look at the data on how prevalent certain things are out there in the market and we follow it up with academic research that tests whether these things are positive or negative and we draw our conclusions from that a lot of the books that are on the market today are really opinion based so they start with a central premise and then the author spends the majority of the book defending why that premise is correct a lot of it is based on that person's opinions and in some cases biases but they're not really evidence driven and in many cases those conclusions may or may not be true but they're not really tested I think the most surprising finding from the book is that a lot of the focus is misdirected in governance today a lot of the attention is placed on features of governance so for example what's the structure of the Board of Directors how much compensation is paid to CEOs and things like that and a lot less attention is paid on the factors that really matter and these are the processes by which the company actually makes decisions so for example a lot less attention is played is paid to the strategy and risk management functions and those are areas where boards can really stand to improve another area where boards can stand to improve is with its CEO succession a lot of CEO succession planning within corporations is was shown to be a more check-the-box solution and not really what we expected we expected that companies would have operational plans in place things that they could do if the CEO suddenly stepped down and they needed to find somebody right away and I think going forward a lot can improve with a new focus on the features and of how governance is run rather than just these superficial factors I think the most surprising finding of the research is that how little impact the research has actually had on practice there's tons of academic research across accounting finance economics corporate strategy and things like that lots of careful thought but I don't think that research has had that much impact in the way people actually think about it you know the Blue Ribbon panels that are filled with clearly well-known people very smart very successful when you read their reports there's actually not much discussion of of the research that either supports and doesn't support some of the findings I think one of the things that we hope the book does is provides a synthesis of the research in a digestible form that the press directors lawyers you know government regulators and alike can actually see that there is a there's a body of work out there that informs you know you don't have to do it yourself it's already being done as part of the scholarship in universities so when we we're actually a little surprised how little impact that sort of sort of had in in these things other kind of more practical things that and we found surprising are the inability of boards they actually put in put in operational succession plans this is a really a key part of risk management and it's it's a pretty it's a pretty serious part of of what boards do I mean ultimately they evaluate and vet the strategy the organization they kind of hire and fire the top management and so you know one of the two issues seems to be lacking a little bit that boards are struggling with lots of things with regard to CEO pay now that's not that surprising in and of itself but the SEC has recently required boards to talk about or the pay practices motivating managers to do excessive risk-taking that sounds like something that board out evaluate but I think we don't really know at this point how do you define excessive risk-taking you know what would it look like you know and then the issue is you know how can you evaluate that and so we actually have some proposals or you know sort of hopefully informed guesses about you know new ways to think about pay how much incentive are you really providing and when it when are you in a situation we start worrying about excessive risk-taking one of the examples that we have in the in the book has a deal with Eli Lilly and they they went through and did a very detailed assessment of excessive risk-taking and their response was to basically you know take out all the lots of the incentive contracts so you got rid of stock options they capped off bonuses and things like that now that may be fine for Eli Lilly but you kind of wonder about what happens if a lot of companies did that I mean it's the incentives that he actually drives the innovation that really motivates people and I think taking these things out is not necessarily a good result for shareholders it may mitigate risk but it may substantially reduce the returns for companies as well we employed a very rigorous and methodical methodology and it took a long time to do that I mean this book was almost three years in the making and with each feature in governance we went through and collected all the literature both from academics and professionals we looked at the data that was available and we looked through you know the popular press to find examples of things that companies are specifically doing in these areas and we also added interviews that we conducted with third-party experts consultants lawyers and practitioners including directors and executives and we took all that information and digested it together in a way that we believe gives the most comprehensive look at all areas of governance in the media older discussions and things like that there's I think there's lots of things that are that are missing first off I think people are trying to do the right thing you know you want to highlight and penalize people where they've had bad governance and they're doing kind of bad things so I think that that's a good thing the issue is what mechanism do you want to use to isolate the ones that are the good ones for the bad ones I think what's missing is everybody or most people out there are really trying to find here's a very very simple yardstick for measuring corporate governance do you have this many directors of this type or you know do you use the pay of this form things like that but I think the problem is it's a lot more complicated than that there are certain differences in organizations and people corporate strategies and things like that that that that basically make a simple yardstick a place to start but not a place they end up you have to think more carefully about what are the choices and it's not a one-size-fits-all set of choices for evaluating corporate governance boards face lots of sensitive issues in and the issues that are really sensitive vary over time in the 1990s 2000 2000s you know we had lots of auto failures the board was very concerned about our is the audit function appropriate do we have sufficient internal controls the Audit Committee of the board was under tremendous scrutiny and now what you see is that the Compensation Committee is that is the committee and the decisions that they're making are the ones that are tremendous scrutiny is it CEO pay too high or repaying the people the right form and there's lots of people on the outside both media but also proxy advisory firms that are that are weighing in on this and it's it actually now is going to shareholder vote through the so-called say-on-pay so I'd say that's a tremendously sensitive issue for the boards the other issues that are that are sensitive our risk management do we actually know what's going to happen if we have a subside a hiccup in the the inputs or the outputs of the firm you know if you have an earthquake in in Japan how how does it affect where they're gonna be able to get our raw material do we have plans in place and things like that what what happens to us if all the sudden interest rates go up or we lose a major customer you know what is our strategy capable of dealing with that so lots of boards are trying to deal with with risk management in one key part of it that we've seen certainly around around the country recently it's a session planning do they actually have somebody the complot that's going to plug in do we know who that person is how comfortable do we feel about that as we replace management I think what's going to happen going forward is I think the next committee of the board is the nominating Governance Committee this tremendous scrutiny now about do we have sufficient diversity on boards do we have the right board members you know the people that come up for evaluation for new board memberships or actually come up through the govern the nominating Governance Committee so how that committee operates so they're doing the right thing are they picking the right people those kind of things I think are clear on horizon the book has lots of important takeaways one of them is that I think you want to be very cautious following blue-ribbon panel recommendations or you know things that you read in the press or whatever presumed to be best practices and when we look at these things in the book from a research perspective if a lot of these things just don't hold up some of them are clearly fine but some of them some of them not so I think the the book really lays it out in a pretty neutral way and gets in there and says what do we actually know about things like should the CEO and the chairman the board be separated you know what do we know about how Jesus structure pay and things like that but I think that the primary message of the book is you have to think a little harder about governance choices you just can't fall all these these standard recommendations yeah in terms of pressing development so the thing we worry about is for lack of a better term the federalization of corporate governance we certainly have seen sarbanes-oxley and go into place it was directed mostly at the accounting function and other other features of the board more recently the the dodd-frank bill which is which has been passed at some form all those being litigated really opens up the board to to lots of inquiries that are basically imposed on them by the government so one of the things is they're opening up proxy access under the rubric of shareholder democracy so if if you your shareholder you ought to be able to vote you know in America and and have some impact on these things with regard to directors that are elected and things like that one of the proposals is if you've owned three percent you or a group have collectively owned three percent of the company for three years you can nominate 25 percent of the board for election so instead of having elections where they're mostly uncontested accepting proxy contests you have a situation here where the outsiders can bring board members to forward for potential elections to the board now that's something that's being imposed on the companies that's not something they would do necessarily as their free will and you kind of wonder you know is that a is that a good consequence or not basically we've actually done a little research around this we find that those kind of proposals seem to be greeted with big negative stock price responses for companies that look like they're gonna be subject to these to these criteria so there's a case where you know the government has in some sense decided that's a good idea have kind of passed this thing but it's like the research results are suggesting maybe it's not such a good idea so hopefully you know the research like that will inform regulators in the government you know what might be a good thing to do but I think right now in the administration there's there's a lot of interest in imposing govern criteria on company that that really you know could have been voluntarily adopted and weren't and that you know the I don't know the trillion-dollar question is is that is that good or not is it better to have regulation or is it better to let the the market operate of course that's the age-old question in economics and I think here's a case where I think we can't weigh in a little bit on this and but I think the federalization of corporate governance is a is a big

Maurice Vega

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