News Corporation Governance Issues

What began as a phone hacking scandal in the U.K. for News of the World
has now mushroomed into a much larger scandal covering several countries and upper levels of News Corporation management. In a model of brevity, Viet Dinh issued a statement on behalf the independent directors of News Corp. today: "The News Corporation Board of Directors was shocked and outraged by the allegations concerning the News of the World, and we are united in support of the senior management team to address these issues. In no uncertain terms, the Board and management team are singularly aligned and committed to doing the right thing."

In light of all that is happening, this brief statement is an excellent summary of what independent directors of a corporation should strive to do. Let's spend a few minutes thinking about the different facets of the scandal facing News Corp.

1. Dual role: Murdoch's dual role of CEO and Chairman cannot continue. Even in the best of times, combining these two roles places too much power into the hands of a single individual. And because that individual controls what information makes it to the full board, the full board is not able to fulfill its fiduciary duties to shareholders effectively.
2. Independent directors: One challenge that corporations controlled by founding families who remain significant shareholders often have is identifying directors who will be truly independent. When a single person or family is responsible for your appointment to a board and could easily oust you from a prestigious and lucrative board appointment, there is a tremendous temptation to pull punches. It is critical that a board's nominating committee identify individuals who aren't afraid to speak up and to ask questions.
3. Board reorganization: News Corp. took the step of establishng an independent committee, the Management and Standards Committee, described as outside of News Corp. The MSC is charged with recommending compliance, ethics and governance procedures. However, the MSC will, according to the press release "report directly to Joel Klein" a News Corp. EVP and a member of the board of directors. As Klein is a News Corp. EVP, this MSC will not be as indpendent as it might be if it reported to a board committee or to the full board.
4. Succession planning: As heads roll, it will be interesting to see whether News Corp. has successors in place and whether the board has confidence in those who have been groomed to take the positions of those who resign or are terminated.
5. Email and document retention policies: The scandal has been a front page reminder of the need for companies to review their email and document retention policies on a regular basis and to ensure compliance with those policies.
6. Internal and external investigations: At this point in time, I would expect that outside firms hired by the independent directors of News Corporation have been engaged and are actively investigating the facts to determine the nature and extent of wrongdoing. Both the internal investigations and the government investigations will take many, many months to complete. This kind of under-the-microscope scrutiny should, in the long run, lead News Corp. and other companies watching News Corp. to make a number of changes with respect to newsgathering, governance and compliance practices.

Earlier today, in a three-hour long hearing a committee member referenced Enron and reminded the Murdochs of the concept of "willful ignorance," suggesting that this scandal could perhaps rival the Enron scandal. The reaction of financial regulators and governments to these types of high-profile scandals will require regulators to face a difficult balancing act. How much regulation is needed? How little can we have, while still providing appropriate protection to the innocent?

CG Changes in Singapore

In a release yesterday, Singapore's Monetary Authority announced the appointment of a Corporate Governance Council to review, revise and augment existing corporate governance rules. Of particular concern is the low number of truly independent directors on the boards of companies in Singapore.

Links to the Consultation Paper and the Proposed Changes are included in the press release linked in this posting. The last round of revisions to Singapore's corporate governance laws was in 2005.

Among the proposed changes are:

1. Independence: That at least one half of the directors should be independent, particularly in those companies where the CEO and Chairman roles are filled by the same person or where founding family members hold several key positions. Serving as an executive officer or being a substantial shareholder of the listed company during the preceding 3 years would render a director not independent, as would other close relationships between a director and such persons. Serving on a board for more than 9 years also means that a director lacks independence.

2. Training: Companies should arrange for and pay for training of directors and should report on this in their annual reports. The nominating committee of the board should oversee this.

3. Director performance: The nominating committe should also monitor performance by individual directors by looking at whether the director devotes sufficient time to performance of board duties. The nominating committee should also determine the maximum number of directorships that may be held and report this to shareholders.

4. Compensation: The remuneration committee should assure that the remuneration consultants are objective. More information should be disclosed to shareholders regarding the pay/performance link and aggregate compensation of the top five (other than directors and the CEO) must be disclosed. Mexico has a similar approach to compensation disclosures, allowing for aggregated rather than individualized disclosure of compensation amounts.

5. Financial disclosures: The board should assure that there are appropriate internal controls and risk assessment procedures and should comment on whether it has received assurances from the CEO and CFO about the accuracy of financial statements and the existance of these controls and procedures.

6. Sharehold relations: Companies should comply with a new statement on shareholder rights, should put all resolutions to a shareholder vote and should announce detailed results of the voting.

Singapore has for many years tried to position itself as having strong and transparent capital markets and these changes should solidify that position. The proposed changes will be open to comment from interested parties until the end of July.

Nigerian CG Changes

An article yesterday reports that Nigeria is working to strengthen corporate governance practices.

The Nigerian Stock Exchange management is looking at introducing a process to certify compliance with corporate governance principles. According to the head of the Nigerian Stock Exchange, the country is in a marathon and not a sprint to build transparent, solid capital markets. The head of the NSE is also interested in expanding the market's offerings from stocks and bonds to other instruments, such as exchange traded funds.

Of Bikinis and Corporate Governance, or Reuters, what were you thinking?

There is a Reuters article in the UK press today about the status of women on corporate boards. This is an important topic and one that I have blogged about previously here and here. The Financial Reporting Council in the UK is considering requiring companies to explain what steps they are taking to add more women to their boards.

The astounding thing about the Reuters piece is that this article about women on corporate boards of directors is accompanied by a picture of a woman in a bikini. Yes, really! Surely there are plenty of pictures of women in business suits, or boards of directors. No picture at all would have been better.

Why would Reuters put a picture of a woman in a bikini in the article? It demonstrates incredibly poor judgment. If the article were intended to have a salutary effect on the status of women on corporate boards of directors, it was completely eviscerated by the picture.

EU Tweaking Governance Rules

Yesterday, the European Union announced that it will consider implementation of new rules to enhance corporate governance practices in EU markets. The Green Paper addresses several areas of concern and posits that the voluntary "comply or explain" approach is not working well in every area. If you want to read more about the comply or explain approach to corporate governance, go to these older posts: the EU's Corporate Governance Forum or the UK's Financial Reporting Council. They explain the fundamental differences between a rules-based approach to accounting principles and corporate governance and a principles-based approach. Other relevant older posts are: here (accounting)and here (internal controls).

The Green Paper, written under the direction of the EU's Internal Market Commissioner Michel Barnier, identifies several key issues where the principles-based approach that gives companies the option of either complying or explaining why they don't is not working well. Through the Green Paper, the EU is soliciting feedback on a number of specific questions.

The three key areas discussed in the paper are the following:

1. Boards of Directors -- The Green Paper addresses issues of what backgrounds and skill sets make for a diverse board having "appropriate professional experience." The Green Paper reviews issues of professional diversity, international diversity and gender diversity. In addition, the Green Paper addresses the time commitment required of directors and asks for comments on whether the EU should limit the number of boards on which someone serves. Other topics addressed are regular external board evaluations, directors' pay, and risk management.

2. Shareholders -- Observing that lack of shareholder interest may have contributed the financial market issues of recent years, the Green Paper examines several shareholder questions, including:
a. Engagement by shareholders through active monitoring of the company, dialogue with management and, where needed, the exercise of shareholder rights to improve the company.
b. Short-term strategies -- High-frequency and automated trading have contributed to short-term holding periods. The EU expresses concern about the short-termism among investors and asks how the EU's rules could be changed to prevent this behavior.
c. The relationship between institutional holders and asset managers -- Current fee and commission structures can be viewed as further encouraging the short-term strategies that do not help with the creation of long-term value. Further, despite the fiduciary duty owed by asset managers to their institutional investors the level of transparency necessary for a healthy fiduciary relationship is not always present.
d. Proxy advisors -- The number of organizations giving proxy advice has proliferated in recent years. The EU observed that some have expressed concern "that proxy advisors are not sufficiently transparent about the methods applied with regard to the preparation of the advice." (For my take on a recent proxy advisor gaffe in the U.S., see this posting about Hewlett Packard).
e. Shareholder identification -- Issuers generally do not know who holds the vast majority of their shares. That's because the shares are held in street name (i.e.
through a broker rather than in one's own name). If issuers had a means of identifying shareholders, this could lead to more dialogue and greater transparency.
f. Minority holder protection -- The Green Paper expresses concern that a "comply or explain" approach can lead to potential abuse by the controlling shareholder(s).
g. ESOPs -- Employee share ownership leads to greater commitment and motivation of employees, but some employees may not diversify sufficiently (remember Enron?). The EU asks how employee share ownership can be promoted in a responsible way.

3. Comply or Explain Approach -- The EU observes that many companies fail to explain adequately deviations from policy. The EU noted, for example, that in Sweden a company need only state the reasons for not complying. There is no requirement that the company explain what approach it used instead.

The Green Paper also notes that CG policies, once adopted by companies, are often mothballed. The company publishes a good policy, but then fails to monitor compliance with the policy on a regular basis. Allowing regulators to do periodic checking on this and the disclosure issue could be helpful to shareholders.

The EU has invited comments on the Green Paper issues by July 22, 2011. Comments can be sent to: markt-complaw@ec.europa.eu

Hewlett-Packard's New Directors: Bad Process, Right Result?

HP has had its share of governance issues over the past several years, including concerns about Carly Fiorina's severance package, corporate spying and Mark Hurd's departure in the wake of a scandal. Now, Institutional Shareholder Services (ISS) has HP in its crosshairs over the nomination of several new directors.

A few days ago, ISS recommended that shareholders vote against 3 nominees. Their selection was, according to ISS, too heavily influenced by the participation of HP's CEO. The board's nominating committee failed, according to ISS, to lead the nominating process, which is that committee's core function. ISS opined that because of CEO Leo Apotheker's involvement in the process, and the interlocking directorates (he serves on boards with some of the nominees), the selection process was tainted.

So the question in my mind is whether, if the process is tainted at an early stage, can the ultimate result still be right? I think the answer is yes.

While some involvement from corporate staffers and the CEO might be expected (such as facilitating meetings and making sure the search firm gets paid), the question is whether the CEO's involvement was too much and whether that involvement invalidates a result reached by a committee of disinterested directors. More information would be helpful, such as whether the committee rejected any of the potential nominees suggested by the CEO and others.

Ideally, each nominee would have no prior connections with Apotheker. But in the real world, there are all sorts of connections between people at this level and between companies. If the CEO knows of good candidates, it would be irresponsible not to suggest those candidates to the nominating committee. And many companies would expect the CEO to meet with candidates at some point before a nomination is finalized. It's a bit of a beauty contest both ways; the nominating committee will likely be interested in the CEO's thoughts and the potential nominees needs a chance to evaluate his or her interest in serving. A visit with the CEO is one of the best ways to gauge this.

I've always had great respect for Pat McGurn and ISS and I am a strong advocate of director independence, but on this one, I think they've made a recommendation that fails to recognize the realities of board selection processes.

Corporate Governance in the Middle East

A posting earlier this week on the Business Ethics web site drew my attention to an article by Alissa Kolderstova on The Second Corporate Governance Wave in the Middle East and North Africa.

The article, published in the OECD Journal: Financial Market Trends, reviews the history of the relatively new concept of corporate governance in Arab countries. Her article identifies the first wave as the evolution in the last decade of governance structures and regulations, with Oman and Egypt developing corporate governance codes in 2002 and 2005. The second wave is a drive to assure enforcement of the laws which are on the books.

While most companies in the Middle East and North Africa (MENA) have traditionally relied on banks for capital, capital markets have begun to develop. What recent coups in the region may mean for continued development is unclear at this time.

The development of markets has forced what the author describes as a "disclosure-averse culture" toward greater transparency and stronger disclosures. Egypt has been at the forefront of countries in the region in adoption of strong governance princples. The recent turmoil and the continued regional instability will undoubtedly scare some foreign investors away, despite strong efforts by the government over the past decade to move toward more robust governance practices.

Two True Things

I have been contemplating the truth of two things this afternoon:
1. Eventually, nearly every country will adopt some type of corporate governance statements, laws or processes; and
2. I will blog about it.

I say these two things are true because today I ran across a brief story on new corporate governance standards proposed by the Azerbaijani Economic Development Ministry. The standards are described as introducing international best practices in Azerbaijan.

According to the article, the new corporate governance standards have been under discussion among regulators at several government agencies. The government plans to conduct training sessions on the new standards for company exectutives in Azerbaijan.

So, when I got up today, I had no idea that I would be blogging about Azerbaijan at the end of the day. Eventually, everyone will pass CG standards, and I will blog about it.

Awards for International Corporate Governance

Over the past 12 months, I have been notified several times of recognition given to this blog. Thanks to the reviewers and readers for this recognition.

Among recent awards and listings are:
1. Being listed as #23 in a listing of the Top 50 accounting blogs here;
2. Being selected as a Top 15 Economics and Finance Blog by J.P. Katz and Associates; and
3. Being named a top Corporate Governance Blog by Online Finance Degree.

Please keep reading and feel free to comment on my postings.

Succession Planning at Apple

In the last few years, I have blogged about succession planning, sharing my thoughts on best practices. I have also blogged about whether companies should have an obligation to disclose health issues faced by top executives. Now, Apple faces an interesting shareholder proposal on just this issue.

The proposal, filed by a union pension fund, will be voted on by Apple's shareholders in February. The proposal calls for the Board to "adopt and dislose a written and detailed succession planning policy." As a part of the policy, the Board will review the plan on an annual basis, develop criteria for a CEO and assess candidates, plan for transitions at least 3 years out, and report annually to shareholders.

The Apple Board has recommended that shareholders vote against the proposal arguing that the company already has a detailed succession planning process and that extensive disclosures could make its most talented executives more likely targets of headhunters. I find that the first part of the Apple response makes some sense. Like most large companies, Apple undoubtedly has detailed succession planning practices in place.

As to the second argument, I am skeptical that reporting to the shareholders on those practices in detail would significantly enhance the chances of a competitor stealing a talented executive. There are two reasons why I don't give much credence to this argument. First, companies are already required to attach to their 10-Ks the employment contracts for their top officers. Hint: you may have to search back several years to find the contract for the person you are seeking. Second, the top officers tend to be fairly high profile anyway. A competitor likely already knows from industry sources and the media who the most talented individuals are.

So Apple, if I were you, I would render the proposal moot by agreeing to report on what I already do.

Pakistan Revising Code of Corporate Governance

Pakistan's SEC has just released for comments proposed amendments to the Code of Corporate Governance 2002. The proposed modifications are designed to help Pakistan continue its efforts to build strong and transparent capital markets. All of these changes are being made to help move Pakistan more into line with international best praticies.

The revisions to the Code of Corporate Governance will strengthen the composition of boards of directors by prohibiting board members and outside audit firms from also serving as internal auditors. In addition, the use of more outside directors is being required and, under the new draft, at least 1/3 (or 3 at a minimum) of the directors must be indpendent. Related party transaction disclosure rules are also being enhanced as part of the Code revisions.

Keeping Your Risk: Wells Fargo Makes the News

Yesterday, Wells Fargo was in the news for a letter written by its Executive VP to regulators. According to John Gibbons, EVP for Wells Fargo, "Rather than being something rare or unusual, it should be common in the mortgage industry to align interests of lenders, borrowers and investor." Huzzah, Wells Fargo!

It may not be a coincidence that major Wells Fargo shareholder Warren Buffett ("Banking is a very good business unless you do dumb things.") has a similar opinion about outsourcing risk through the use of D&O policies and has held that opinion for many years.

His Berkshire Hathaway letters to shareholders are always a good read. Here's an excerpt from last year's letter:

The CEOs and directors of the failed companies, however, have largely gone unscathed. Their fortunes may have been diminished by the disasters they oversaw, but they still live in grand style. It is the behavior of these CEOs and directors that needs to be changed: If their institutions and the country are harmed by their recklessness, they should pay a heavy price – one not reimbursable by the companies they’ve damaged nor by insurance. CEOs and, in many cases, directors have long benefitted from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well.

Buffett has believed for many years that the purchase of D&O insurance is another form of offloading risk that should be borne by a company's officers and directors. If you know that if you make a disastrous decision there will be insurance to pay your liabilities, you might not be as prudent as necessary. Remember, the business judgment rule provides a defense, provided that you act in a manner that a reasonbly prudent person would in the conduct of his or her own business.

It's possible that Buffett's views on offloading risk have filtered down to Wells Fargo, but perhaps Wells Fargo was just a good match for his investing philosophy. After all, Buffett looks very closely at management in making his investment decisions. It looks like the senior folks at Wells Fargo have the same prudent views as Buffett.

UK Guidance for Unlisted Companies

There has been very little guidance over the years for unlisted companies. In fact, it's not a topic I've really thought much about despite many years of work in the area of corporate governance. The void has been filled, at least in the U.K., through the report just released by the Institute of Directors, the European Confederation of Directors' Associations and Deloitte. The report, Corporate Governance Guidance and Principles for Unlisted Companies in the UK, provides a blueprint for those running unlisted companies to assure practices that help maintain key relationships among the directors, employees and shareholders and to assure that officers and directors comply with their legal duties.

Thanks to the IOD, ECDA and Deloitte for the report. It's well done and provides very sound guidance in an area where such guidance was completely lacking. Most of the principles set forth in the report apply equally in other countries, as well.

Twenty Five Years of Corporate Governance

A recent Business Week article by Julie Hembrock Daum looks at changes in corporate governance over the past 25 years. Coincidentally, I worked on my first securities fraud class action 25 years ago. In a way, the governance changes of the past 25 years are events that I have witnessed and sometimes been a part of in a very small way.

Twenty five years ago, we didn't even really hear the phrase "corporate governance." The Cadbury Report from 1992 defined the phrase as "the system by which companies are directed and controlled." Now, 25 years later, it's a phrase we even hear on the nightly news and we all know that poor corporate governance practices contribute to frauds and a lack of confidence in the securities markets.

Daum notes that there have been some really significant changes -- splitting the chairman and CEO roles, having fewer inside directors, higher retainers for directors and better succession planning practices. What hasn't changed? Women and minorities are still underrepresented on boards of directors. According to the article, the issue of representation of women and minorities wasn't even mentioned in the Spencer Stuart Board Index from 1986.

There have undoubtedly been many very good changes. Disclosure laws are stronger in almost every nation, succession planning is something in which most boards do engage on an annual basis and boards are better about evaluating their own performance and seeking to improve where necessary.

Philippine Market Rehabilitation

Just this week the Philippine Stock Exchange announced new corporate governance rules. The Philippines were ranked 11th of 11 Asian countries in a review last fall of corporate governance standards by the Asian Corporate Governance Association.

The Philippines has struggled for credibility with investors due to lax governance and disclosure standards, enforcement issues and turnover at the PSE. The new approach calls for the establishment of the Maharlika Board, a special listing segment at the PSE comprised of a group of Philippine companies that adhere to strong corporate governance practices. "Maharlika" comes from a Sanskrit word (maharddhika) which means "a man of wealth, knowledge or ability."

While admittance into the Maharlika board is voluntary, the hope is that by providing this special distinction to Philippine companies with practices in line with international corporate governance standards, other companies will follow suit. This should ehhance investors' currently lacking confidence in the PSE.

PWC Annual Corporate Directors Survey

PWC just released the results from its 9th Annual Corporate Directors Survey. The far-reaching survey compiled results based on more than 1,000 responses from directors. You would think, after several years, of reeling from scandal after scandal and new law after new law, that some of the excesses and other issues of the 1980s would be long past. Not so, according to the survey results. Here are a few key findings:

1. A majority of directors say that boards still aren't controlling CEO compensation like they should be. Maybe Compensation Committees need to insist on comparison to other peer groups.
2. In the risk management area, most directors feel that there isn't a need for a separate board-level committee.
3. Boards are still struggling with adding diversity -- both racial and gender.
4. A substantial minority of board members believe that their boards should be more heavily engaged in succession planning. I've argued before that succession planning is arguably the single most important function of a good board.

India Enhancing Disclosure Practices

Up-and-comer India is in the process of strengthening its disclosure rules, particulary those dealing with related-party transactions. Sebi chief C.B. Bhave commented at a recent OECD conference that the regulator will be more vigilant in the future regading related-party transactions. Auditors should play a strong role in identifying abusive transactions and mutual funds should exercise their influence to discourage abusive transctions and to encourage more frequent and higher quality disclosure to shareholders.

The OECD has, according to the Times of India, recommended that Sebi work to better define related-party transactions and the disclosure rules governing them. Further, companies engaged in related-party transactions should develop strong internal controls to monitor and assure accurate reporting of such transactions.

Russia Still Faces Governance Challenges

A Reuters article on Friday discusses some of the challenges of corporate governance in Russia. Russia faces the same types of problems faced by many nations.

Although Russia has corporate governance laws on the books, the challenge is in ensuring consistent, thorough and fair enforcement of those laws. Until the court systems are better developed in Russia, corporate governance will not make the strides it should, international investors will eschew investments in that country, and economic development will be slower than it could be.

Two related problems are discussed in the article. First, enforcement is meager and enforcement scarce. Even when red flags exist, resources may not be committed to investigate and prosecute those responsible. Second, if an investigation does occur and charges are brought, problems in the courts themselves mean inconsistent enforcement of existing laws.

Until Russia steps up to the plate and consistently enforces the corporate governance laws it has on the books, international investors will avoid substantial investments in Russia and its economic development will be stunted.

FAS 5 and IAS 37: Big Changes for IFRS Companies

It's been 3 years since I last blogged about FAS 5 and how pampered we've been in the U.S. with our measely terminology of probable, reasonably possible and remote all these years. IAS 37 has 27 levels of likelihood.

A posting earlier this summer on the Deloitte web site explains some of these issues in greater detail.

FAS 5 has provided guidance on contingent liabilities for the past 35 years. For companies choosing to follow IFRS in their financial reporting, IAS 37 will mean significant changes in reporting contingent liabilities.

FAS 5 requires financial statement disclosure of contingent liabilities that are both probable and reasonaby estimable. Similarly, under IAS 37, contingent liabilities are disclosable if a company has a present obligation arising from past events and it is more likely than not that a payment will be required and the amount can be reliably estimated. Though FAS 5 and IAS 37 are similar up to this point, there are significant differences from this point.

Under IAS 37, for example, almost any degree of likelihood creates an estimable amount, even though the range of outcomes may be significant. And even if it's impossible to determine the range, the contingent liability should still be disclosed.

Companies thinking of adopting IFRS should review carefully the ways in which IAS 37 may impact their financial statements. The contingency disclosures could be much different than under FAS 5.

Thoughts on Succession Planning

With Mark Hurd's sudden ouster at HP, my thoughts turned to the topic of succession planning, why it's so important and what the board's role is in planning the future leadership of an organization. Sudden departures are frequent enough that regular succession planning should be a part of every board's annual agenda. In fact, arguably the most important role of the board is overseeing the succession process.

In the past decade, we've had CEOs who died in surgery and others who -- like Mark Hurd -- were ousted quickly in the wake of some scandal. And when it comes to likely successors, those within a company who have been identified as the CEO's most likely successors are likely to be those who are driven and who will be heavily recruited by others. What happens when the most likely successors are recruited away?

Here are a few thoughts on what good succession planning practices look like:

At least annually, the full board or some committee (usually the compensation and nominating or governance committee) should have a discussion with the CEO about successors for his or her position. The CEO should identify those within and even outside the organization who have the skills to lead the organization.

For those within the company, the CEO should analyze the skills these individuals already possess and should note competency gaps. A plan should be designed for each to fill the competency gaps over the next few years. For example, if one likely successor has significant operations experience, but little experience on the financial side consider ways that individual can gain greater expertise in the financial area. Can reporting relationships be changed? Can he or she serve on certain committees where financial issues are discussed in great detail?

For these likely successors, it is also extremely important to pay close attention to the salary and perquisites he or she is receiving. Are salary and benefits on par with similar positions at other organizations? You can find out what the CEO and other most highly compensated officers are making from the company's proxy statement each year. Sometimes you can dig a little deeper by looking for employment contracts with other senior executives that are filed as attachments to the company's 10-K each year.

Those who will be likely successors to the CEO should also be encouraged to develop successors. After all, it's much easier to promote someone when it is fairly clear who can fill their role.

University Presidents on Corporate Boards

The New York Times ran an article last week about academic types serving on corporate boards. The article, The Academic-Industrial Complex, discusses several examples of academic administrators and professors who serve on the boards of directors of large corporations.

As the top academic official at a midwestern university, a former Wal-Mart executive, and a former lawyer for the SEC, this article struck a chord with me. The thesis of the article is that, although academics can bring some value to boards, most academics are really not well qualified to serve on corporate boards and many of them serve on too many boards to be effective.

Here are a few of my thoughts about the issues discussed in the article:

1. Back scratching -- The back scratching occurs in many ways. Academics can bring new perspectives to the boards on which they serve and can add prestige to the board if they are with a well-known university. They can also add to the board's diversity. In a time when the most senior executives at most corporations are still white males, the diversity that is more common in academia means that the board can be more diverse if they search out members from outside of the corporation's industry.

The academics make money and make contacts that can be both personally useful and useful for their institutions.

2. Lack of understanding -- The article makes much of the fact that many academics really don't have the backgrounds to understand much of what happens in the boardroom. I do agree to some extent based on my experiences. There are undoubtedly many in academia who could contribute in meaningful ways on a corporate board, but those whose careers have been solely academic would not -- at least initially -- be as able to understand and contribute on certain types of issues. They could, however, be able to give sound guidance on certain types of issues and, in time, could become sufficiently knowldgable about the industry to weigh in on industry-specific issues.

3. Conflicts of interest -- The lucrative pay for some board positions is more meaningful to an academic than, say, to an executive with another corporation who already makes a seven-figure salary. I don't believe that the level of board compensation has been held to impair someone's ability to act in a fair and unbiased manner, but it is of some concern. In addition, if the corporation donates to the academic institution, then the academic might not be a disinterested director for purposes of serving on the Board's compensation committee.

4. How many boards? -- There are examples of university presidents who serve on several boards of directors. Running a university is a demanding job and taking the time out to prepare for and attend board meetings can be difficult. I have trouble imagining someone serving as a university president, while also serving in a meaningful way on more than a couple of outside boards (and this includes non-profit boards or other similar activities).

5. Academic freedom -- The authors note that some might have concerns that a university president's service on a board would have a chilling effect on academic freedom at the university among faculty who might otherwise criticize the corporation. It could be that there are some universities where this might be a legitimate concern, but at most academic freedom is held sacred and tenure provides protection against reprisals.

In the long run, a university president or senior academic official who has had business experience can get up to speed much more quickly and is more likely to be a contributor on a corporation's board. Other academics can provide some valuable insight over time, provided they are not stretched too thin.

Risk Premiums for Poor Governance

There's a Bloomberg/Businessweek article out that discusses the risk premium that must be paid to finance infrastructure projects in countries viewed as having poor corporate governance practices. The article
VTB-Led Group Pays Twice Emerging-Market Rate on Loan notes that the cost to expand St. Petersburg's Pulkovo Airport is nearly twice that for similar projects elsewhere. The authors, Jason Corcoran and Karen Eeuwens, looked at the syndicated financing arrangement for the Pulkovo project because it is the first project of this scale not to use the Russian government to back its loans.

According to an attorney quoted in the article, banks demand higher interest spreads because of the perceived risk due to inadequate Russian laws. Among the areas of law of concern are corporate governance laws.

While Russia certainly isn't the riskiest nation (it ranked 20th in a recent study), this deal highlights the risk premium lenders expect when lending money for projects in nations where laws protecting property rights and assuring good corporate governance are inadequate. Couple that with other economic and political problems, and the risk premium expected is even greater.

Wall Street Reform (a/k/a Whizzer) Act

Sometime this week, President Obama should sign the Dodd-Frank Wall Street Reform and Consumer Protection Act. It's an act that cries out for a catchy name. My proposal? WSR (pronounced "whizzer").

As SEC Chair Mary Schapiro said recently, "the SEC's job is not to define for the market what constitutes 'good' or 'bad' governance . . . . Rather, the SEC's job is to ensure that its rules support effective communication and accountability." In other words, the SEC doesn't prohibit the selling of rotten eggs to investors; it just requires that the sellers tell you how rotten the eggs are.

In response to the passage of the act and Obama's signing of it sometime this week, the SEC minions will begin a lengthy and tedious spate of drafting to craft the specific regulations that implement the new law.

I've spent a little quality, cure-for-insomnia time looking at the provisions of the new law, and want to point out a few highlights and lowlights:

1. Say-on-pay -- At least once every 3 years, shareholders get to vote on executive pay. The vote is precatory, and voting could be required as early as the 2011 shareholder meetings. Previously, shareholders were largely limited to voting on stock plans under which executives were granted options, restricted stock and similar things. The compensation committee, comprised of directors that the shareholders elected, reported annually to shareholders on executive compensation and also voted on bonuses and other pay that caused pay to exceed $1 million per person (this wasn't required, but IRC section 162(m) doesn't allow a company to deduct such pay unless the performance targets are set by disinterested directors).

2. Broker Voting of Shares Sans Instructions -- The exchanges must prohibit brokers from voting shares for which they have not received voting instructions from the beneficial owners. It will be interesting to see what effect this provision has on quorums; it may mean good business for the proxy solicitation firms.

3. Compensation Committee Membership -- The new law essentially codifies the independence rules already in place as part of the listing standards for each exchange. The Compensation Committee will have the authority to appoint and oversee the work of any compensation consultants, as well. This is a departure from the usual process of the company's HR executives engaging the consultants and then reporting to the committee.

4. Compensation Disclosure -- The SEC must amend its disclosure rules to provide for closer linkage between an issuer's financial performance and executive pay. Financial performance is already included in the proxy statement, as is executive pay. The yet-to-be-written rules will require that these two items be discussed in greater detail.

A second provision (I'll call it "the Ben and Jerry's provision") requires that the issuer disclose median pay for all other employees of the issuer. The value of benefits would be excluded. For seasonal industries or those with a high level of part time employees, it is unclear whether they are covered by the Ben and Jerry's provision or whether the SEC either must or may include provisions to address their pay.

5. Hedging -- Under WSR, the SEC will be drafting proxy disclosure rules that require employees' and directors' hedging activities to be disclosed. It makes sense that the SEC would be expected to address activities that protect officers and directors from fluctuations in the price of the underlying securities. Drafting rules that cover the difference between a Rule 10b-5-1 trading plan and equity collars or forward contracts sounds headsplittingly tricky.

There are a myriad of other interesting provisions, but these are the attention-getters for me. Perhaps I'll write more when I wake up from my nap.

New UK Stewardship Code

The UK's Financial Reporting Council published The UK Stewardship Code earlier this week. The introductory paragraph contains a statement that "The Stewardship Code aims to enhance the quality of engagemetn between institutional investors and companies . . . ." The Stewardship Code complements the Corporate Governance Code, which was also issued this summer.

The Stewardship Code is particularly noteworthy in that it sets forth principles that should guide institutional investors in discharging their stewardship responsibilities. Seven principles are set forth to guide the institutional investors, and each principle is explained in detail. The seven principles state that institutional investors should:
1. publicly disclose their policy on how they will discharge their stewardship responsibilities;
2. have a robust policy on managing conflicts of interst in relation to stewardship and this policy should be publicly disclosed;
3. monitor their investee companies;
4. establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value;
5. be willing to act collectively with other investors where appropriate;
6. have a clear policy on voting and disclosure of voting activity; and
7. report periodically on their stewardship and voting activities.

It will be interesting to see how institutional investors implement the Stewardship Code. A companion document on implementation
explains the steps that institutional investors should take to implement the code. The FInancial Reporting Council has noted that it will begin with a "comply or explain" approach to the Code, requiring institutional investors to note on their websites whether they comply with the Code and, if not, to explain why.

PCAOB Decision from the Supreme Court

When I left the public company I worked for to go into academia several years ago, some of my friends told me I was escaping SOX. They framed it as a good-natured accusation, but were actually jealous. Earlier today, the US Supreme Court ruled on a controversial portion of SOX in Free Enterprise Fund v. PCAOB.

The PCAOB case deals with the issue of what powers may constitutionally be given to an administrative body like the PCAOB. The PCAOB was created as part of SOX and is similar to self-regulatory organizations like the NYSE, which have rule-making authority and also have power to investigate members and issue sanctions against them. In the case of the PCAOB, the members are audit firms that audit public companies.

The Free Enterprise Fund argued that the PCAOB is unconstitutional because it violates the principle of separation of powers. The Supreme Court found that the layers of organization above members of the PCAOB created a restraint on removal of the Board's members that is unconstitutional. In the case of the PCAOB members, the President is unable to assure tha the Board members effectively carry out their duties. The Presidential power to remove appointed officers for good cause must not be too limited, or the check on agency power is ineffectual.

Other challenges to the PCAOB and SOX were also brought, but the Supreme Court did not find those unconstitutional.