Transcript Corporate Governance and Sustainable Value Creation

Corporate Governance and
Sustainable Value Creation
Institute for Sustainable Enterprise
April 21, 2006
Beth Young, The Corporate Library
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What is Corporate Governance?
• System of assigning rights and
responsibilities to participants in the
corporate enterprise
• Narrow view: shareholders, management
and the board are participants
• Broad view: all of the above plus
employees, suppliers, creditors, customers
and/or communities
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Focus on Process
• Corporate governance focuses on the
identity of the decision maker, the available
information and the mechanisms available
to redress bad decisions
• Examples:
– Requirements that independent directors
make certain decisions
– Shareholders’ rights to elect directors
– Requirements that shareholders approve
equity-based compensation plans
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Focus on Process
• Why does corporate governance focus
almost exclusively on process?
– Belief by policy makers that:
• The right process will more often than not lead to
the best outcome
• Dictating substantive outcomes is unwise and
inefficient
• The markets—most of all, the ability of shareholders
to sell their stock—will backstop corporate
governance rules and discipline decision makers.
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Process Affects Substantive
Outcomes
• The identity of the decision maker matters
because of differences in incentives, culture,
time horizons, conflicts of interest and other
factors
• The quantity and quality of information
provided to the decision maker shapes the
ultimate decision
– Ex: executive compensation disclosure
requirements
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The Role of Transparency
• Transparency is a necessary but not
sufficient condition for influencing behavior
• Adequate information allows decision
makers to be held accountable
• The process of disclosure itself can change
behavior and the locus of decision making
around it
– Ex: risk management
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Convergence of Governance and
Corporate Responsibility
• Until recently, corporate governance and activism
and corporate responsibility activism were very
separate
• Increasingly, the two are converging:
– Governance activists see corporate social behavior as a
window into business risk, strategy and prospects (Ex:
CII, governance raters)
– Social activists see governance as a way to strengthen
outside influences and encourage optimal decision
making processes (Ex: campaign ExxonMobil, Investor
Network on Climate Risk)
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Accountability
• “I promise you, we will never again risk Enron’s
credibility in business ventures without first
making sure we thoroughly understand the risks.”
Ken Lay, 1987
• “One cannot say that the checks and balances
against excessive power within the old WorldCom
didn’t work adequately. Rather, the sad fact is that
there were no checks and balances.” Breeden
Report
• Accountability means enforcing decision makers’
responsibility to act in the best interests of the
corporation.
– Who gets held accountable and by whom?
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“Best Interests of the
Corporation”
• What does this phrase mean?
– Shareholder primacy norm
– Real-life practice (Ex: Time Inc., constituency statutes)
– Time horizon
• The problem of measurement/quantification
• Who decides what it means?
– The board of directors—exercising oversight power
– Shareholders—making voting decisions
– Courts—deciding whether directors or officers have
acted improperly
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Management Accountability
• The board holds management accountable by
–
–
–
–
Hiring and firing
Compensating
Overseeing financial reporting
Participating in/overseeing strategy
• How do/should directors differ from managers?
• Barriers to board effectiveness in promoting longterm approach to value creation (Ex: Coca-Cola
director comp’n, director nomination processes,
succession planning)
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Board Accountability
• Shareholders hold the board accountable by:
– Dialogue/public criticism
– Electing/removing directors (Ex: Marsh &
McLennan)
– Voting on major transactions
– Voting on non-binding shareholder proposal
– Suing for breach of fiduciary duty
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Shareholders
• Can shareholders effectively promote
sustainability and long-term value creation?
– Patient long-term capital: pension funds,
foundations and endowments
– Investors with shorter-term liabilities
– Incentives within asset management firms (Ex:
HP/Compaq and Deutsche Bank)
– Quantification and tradeoffs
• Fiduciary duties and responsible ownership
– “[The shareholder] may be innocent in fact, but
socially he cannot be held innocent.” Justice
Louis Brandeis
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Executive Pay
• Executive compensation tests the ability of
boards to integrate strategic planning and
incentives, hold management accountable
and uphold commitments to transparency.
• “In judging whether Corporate America is
serious about reforming itself, CEO pay
remains the acid test. To date, the results
aren’t encouraging.” Warren Buffett (2004)
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Executive Pay and Sustainability
• Skyrocketing executive pay is representative of
growing income inequality
– In 1980, the average CEO made 80 times the average
worker’s salary; by 2004, that multiple had risen to 431.
• Retirement security: while workers’ defined
benefit plans are frozen or terminated, executives’
pensions grow:
– Pfizer’s McKinnell: $6,518,459/yr.
– ExxonMobil’s Raymond: $6,500,000/yr
– AT&T’s Whitacre: $5,494,107/yr.
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Executive Pay and Incentives
• Corporate governance’s narrow model of human
behavior: “I don’t get out of bed for less than
$10,000 a day.” Supermodel Linda Evangelista
• What does executive pay incentivize?
– Difficult to tell how incentive pay works
– Almost impossible to tell how compensation serves
strategic goals
– Little use of non-financial benchmarks—those that are
used are often fallbacks to provide compensation when
financial criteria are not met
– Use of market-based criteria duplicates equity
compensation’s incentives
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Equity-Based Compensation
• Pay for performance and alignment with
shareholders—has this idea held up?
• What have we learned about options?
– Encourage riskier behavior
– No downside
– Executives value them less than shareholders
think they cost
– Link to accounting fraud, managerial
opportunism
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Internal Pay Equity
• Executive compensation is not only
scrutinized by outsiders—impact within the
company as well
• Becomes part of corporate culture—studies
show at companies with overpaid CEOs,
other c-suite executives are usually overpaid
as well
• Shared sacrifice and executive pay (Ex:
AMR, Delta, Delphi)
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Ownership Demographics and
Corporate Governance
• Range of ownership structures and
demographics
• The role of passive investment strategies:
out to lunch or the ultimate long-term
investors?
• Empirical evidence on ownership and
monitoring
• Employee ownership
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Conclusions
• Responsible corporate governance can be a
tool to promote sustainable business
practices, but reforms are necessary at the
management, board and shareholder levels.
• Levers on the shareholder side include:
–
–
–
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Organizing beneficial owners
Strengthening accountability mechanisms
Continuing to promote transparency
Taking incentives seriously
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