by James Woolery
The boards of public companies are increasingly being assessed by a hoard of short-term focused “activist” investors and an increasingly third-party-advised stockholder base that relies heavily on proxy advisory firms to make important voting decisions for them. It is estimated that over 75 percent of all shares of public companies are held in a managed fund or institutional account.
Institutional Shareholder Services (ISS) and Glass Lewis control 97 percent of the market for proxy advice; and the two dominant proxy advisors reportedly affect 38 percent of votes cast at U.S. public company shareholder meetings. Their dominance in the proxy marketplace not only affects numerous votes but, more importantly, how companies manage and deal with their shareholders. Both firms wield enormous influence without having “skin in the game.” Perhaps even more concerning, given the influence they have on public companies, the proxy advisors (i) are understaffed and therefore establish generic voting recommendations and (ii) profit from engaging in activities involving material conflicts of interest, including marketing their advisory services to many of the same companies for which they provide proxy recommendations. In addition, Glass Lewis is owned by an activist fund with an agenda.
Unhealthy Influence
“Proxy advisory firms are unregulated; more significantly, they operate without any applicable standards—either externally imposed or self-imposed—and do not formally subscribe to well-defined ethical precepts, while cavalierly rejecting private sector requests for transparency in the formulation of their proxy advice, as well as increased accountability for the recommendations that they make,” said Harvey Pitt, former chairman of the Securities and Exchange Commission (SEC), in representing the U.S. Chamber of Commerce before a June 5 meeting of the House Subcommittee on Capital Markets and Government Sponsored Enterprises. “This lack of any operable framework for such a powerful presence on economic growth and corporate governance is unprecedented in our society.”
Subcommittee Chairman Rep. Scott Garrett said that “proxy advisory firms have increasingly teamed up with unions and others to push proposals that are generally immaterial to investors and often reduce shareholder value.” Mr. Garrett added that “proxy advisory firms have increased the costs of doing business for many public companies and disincentivized private companies from going public, all without a corresponding benefit to investor returns.”
While touting a commitment to transparency with respect to the procedures they use in formulating voting recommendations, the proxy advisors disregard a number of key factors. First, with respect to a number of important votes required by all public companies, the proxy advisors have established a “one size fits all” principle. Little consideration is given to either the specific facts relating to the company that is soliciting the vote, or to the investment principles of the fund or institution that is relying on the recommendation. A second significant issue relates to the solicitation of market information in formulating a recommendation. Numerous problems have been documented in the proxy advisors’ data collection methods, the size and composition of the participant peer pool, and potential bias errors in market surveys relied on by the proxy advisors.
Nonetheless, a National Association of Corporate Directors publication has stated that “over the past few years we have seen an increased reliance on the vote recommendation services being provided on an unregulated basis by proxy advisory firms. Institutional shareholders are often purporting to fulfill their fiduciary voting obligations, in part, by relying on the recommendations provided by these firms.”
Concern over the power of the proxy advisors has grown over the past several years and is currently the focus of a number of business organization initiatives, as well as a Congressional hearing that is considering requiring the registration of proxy advisors and the regulation of their activities. The U.S. Chamber of Commerce has dedicated significant resources to combating abuses by proxy advisory firms.
How Proxy Advisors Came To Be
In 2003, the SEC required investment advisers who exercise voting authority over client proxies to adopt various policies and procedures designed to ensure their proxy votes coincide with the best interests of their clients. Advisors began to worry about their legal liability to fulfill a fiduciary obligation to vote. And as the issue of potential liability was considered, the conclusion was that it was safer and more cost-efficient to rely on a “professional” advisor. The ensuing run to safety from potential litigation created the unintended consequence of blind reliance on ISS and Glass Lewis, with the thought that no one can be negligent for following “professional” advice.
SEC Commissioner Daniel Gallagher recently criticized the ability of fund managers to blindly follow and hide behind the influence of ISS and Glass Lewis, saying “no one should be able to outsource their fiduciary duties.”
Market Dominance Notwithstanding, Proxy Advisors Are Not Invincible
Recently, a number of larger funds, including Blackrock and Vanguard, have been breaking away from strict reliance on ISS and Glass Lewis and have started to conduct their own independent analysis to determine how to best vote their proxies. The Wall Street Journal reported on May 22 (“For Proxy Advisors, Influence Wanes”) that, “big firms that sell recommendations on how to vote in corporate elections are losing some of their relevance, as companies more aggressively court key investors ahead of big votes and those investors handle more of the voting analysis themselves.”
Moreover, a May 18 New York Times article echoes the notion that giant asset managers are increasingly flexing their corporate governance muscles by studying the relevant issues themselves, with due consideration to the economic interests of the shareholders they represent.
Shareholders’ rejection of a recent proposal aimed at splitting the dual roles of J.P. Morgan Chase & Co. Chairman and CEO Jamie Dimon is a testament to both the investment advisors appropriately making their own decisions and to the power of boards to combat the often cavalier recommendations of the proxy advisors. ISS and Glass Lewis firmly backed the splitting of the Chairman and CEO roles; however, only 32 percent of the shares voted agreed with the recommendation of the proxy advisors.
Our view
Clearly, it’s time to let shareholders know that the proxy advisors are not necessarily motivated to provide value to your company. There is simply too much evidence to the contrary. Boards should not be afraid to challenge proxy advisors, especially when their conclusions do not increase long-term shareholder value, or are not supported by the facts. There are several paths to consider to ensure that recommendations made by the advisor are balanced and fairly reflect the interest of your shareholders.
First, consider supporting the effort to require registration and regulation of proxy advisors. Communication, either directly or through well-positioned liaisons, is crucial, as the Subcommittee on Capital Markets and Government Sponsored Enterprises in the House Committee on Financial Services is still actively considering the case for oversight of advisors. Although there has been significant testimony relating to general problems with ISS and Glass Lewis, specific examples of bad practices should be brought to the Subcommittee’s attention. The SEC should also be made aware of specific bad practices by proxy advisors.
Second, influential business organizations, such as the U.S. Chamber of Commerce and Business Roundtable, are focused on the negative impact of proxy advisors and their lack of accountability. You can lend your support to their efforts by establishing a relationship with the appropriate committees that are advocating for legislative solutions to bad practices in the proxy advisory industry.
Third, and perhaps most important, be skeptical of the advisory firms’ work product. Discuss the procedures and results with ISS and Glass Lewis. Make sure they understand the relevant facts that are applicable to your company. If the proxy advisors don’t reflect the facts in their work product, challenge them and communicate directly to your shareholders. Make sure your shareholders understand your position and, if appropriate, your specific reasons for disagreeing with the proxy advisors. ISS and Glass Lewis cannot be allowed the final word to your shareholders. This type of shareholder campaign should start early (before there is a debate with the proxy advisors) to be effective, and must involve the most senior members of company management and the board. Most importantly, company leaders can mitigate the influence of proxy advisory firms by proactively communicating with shareholders on an ongoing basis.
As proxy advisory firms, in the opinion of some, become the sentinels of executive pay and the champions of special interest groups, their actions are bound to come under increased scrutiny. A corresponding increase in transparency and accountability is likely the most prudent response.
I WISH I WERE ON YOUR BOARD OF DIRECTORS!
IMAGINE
BASIL VENITIS
ON YOUR BOARD
OF DIRECTORS!
In the Venitis paradigm, a board serves as a check on a cowboy CEO. Boards often lack the intestinal fortitude for the level of risk taking that healthy growth requires. Board members are supposed to bring long-term prudence to a company, but this often translates to protecting the status quo and suppressing the bold thinking about reinvention that enterprises need when strategic contexts shift.
Conservatism tends to grow with the scale of the enterprise. At a very young company, directors do things early on that, have they not succeeded, would have led to their failure. Fresh boards consider those ambitious things to do. But old boards explore a couple of things that would be very high risk and decide not to pursue them. Because they’ve grown, the risk-reward envelope has changed shape, and there’s a lot more value at stake.
Directors’ risk aversion is driven by fears of bad press. The rise in stakeholder and proxy-analyst pressures has made directors sensitive to any decision that might provoke a negative reaction from the media, proxy-advisory firms, institutional analysts, or activist investors.
During a discussion about a merger, a director might point out that the company is front-page news for other reasons, and that a consolidation would likely fuel further media attention. The risk appetite is out of balance. Many corporate directors are wasting time on image topics when they need that time to debate business issues.
Directors too often put self-interest and self-preservation ahead of shareholder interests. They like their board seats, because of the prestige. They can be reluctant to consider recapitalization, going private, or merging, because they might lose their board positions! In many situations, directors have a merger not go through because of who was going to get what number of board seats.
If directors join a board because of status or reputation or are risk-averse because of legal liability, then they are not as interested in making money, and they don’t represent the interests of the shareholders. For a business to thrive, both management and the board must always focus on long-term shareholder value.
One of the most important functions of the board is to insulate the CEO from short-term considerations. Although you can’t shout in media reports that the board is looking out for more than just the profit motive of today’s shareholders, directors still have a responsibility to provide air cover for management decisions that look beyond the next quarter’s, or even the next year’s, earnings.
In the Venitis paradigm, no one should accept a director role unless he is willing to thoroughly prepare for boardroom discussions. Well beyond reading the briefing books sent out a week or more before meetings, directors should make sure they understand the workings of the company and stay abreast of industry developments. If you don’t take the time and effort to learn the business, the CEO can’t really have a dialogue with you.
In the Venitis paradigm, CEOs have a responsibility to keep directors in the know. Formal board minutes are sparse and legalistic and can’t be counted on to trigger memories of earlier board discussions and conclusions. It’s easy to lose the continuity of thought from meeting to meeting.
If directors want more communication between their regularly scheduled meetings, a CEO should send an update letter in the middle of each quarter. And he shouldn’t hesitate to pick up the phone. If a CEO is dealing with a highly sensitive subject, he should call the lead director.
Compensation issues are increasingly a big deal; when one comes up, a CEO will talk to the HR committee to make sure they are on the same wavelength. All this between-meetings communication is necessary, because it’s a complex, complicated business. A CEO sends a weekly Sunday morning an informal e-mail to directors. He just wants them to know what’s on his mind.
With most topics, management can overwhelm the board with the facts, but that doesn’t mean management is right. The Venitis paradigm advocates a board of well-informed directors so that management doesn’t have to carry the burden of keeping the board up to speed. When the board has a collective sense of the issues, it can discipline the discussion.
When a company is facing a big decision, the Venitis paradigm gives directors extra time to conduct due diligence and to deliberate. With key decisions, nobody is going to present an idea and ask for resolution in the same cycle. They’ll let the board know their thoughts and allow for conversation and discussion. The decision might be made at the following board meeting, or maybe the issue gets deferred until their next meeting, and they discuss it again.
Some CEOs would pack the board with like-minded cronies. But most CEOs don’t want a board populated by their golf buddies. In the Venitis paradigm, diversity is required in order to bring perspective and specialized knowledge to bear on important deliberations. It’s important to have directors from outside the company with different skill sets.
The Venitis paradigm abhors the celebrity director — the unengaged board member whose main contribution is star power. A marquee name on the board has a tiny marginal impact on overall corporate image. More likely, directors get a certain amount of prestige and social standing by saying they’re on a board.
There are many professional directors, who’ve retired from full-time employment. By some estimates, about a third of new board members fall into this category, and the concern is that their first interest is the preservation of their board seats. You want it to be a minority group that is doing it for the income.
There is an absence of energetic debate in the boardroom. One reason such debate is lacking is that conflict aversion sets in. On the one hand, that’s surprising, given that the room is full of opinionated, powerful people; on the other hand, it fits with what we know about the psychology of teams.
A fraternity culture can easily take hold in the boardroom, suppressing discussion and disagreement. In the boardroom, the thinking is you have to be equal, don’t be overwhelming or dominant, don’t hurt feelings, and don’t take someone’s chair. It’s all about getting along.
The Venitis paradigm strikes the right balance between the necessities for collegiality and for the board to function effectively as a team. You want to deal with multiple points of view and not make it hard for people to express their views, but you don’t want to have overpronounced collegiality that allows any person to dominate.
A bad habit is when directors take their opinions outside the open boardroom discussions, where they can’t be contrasted and integrated with other views. A director might drop in on the CEO after board meetings, often trying to overturn a decision or divert the direction the board was taking. A director might storm out of many board meetings on principle. He might pride himself on raising difficult subjects, but he isn’t willing to have a debate.
There is a superficial thinking of the corporate governance. The board is a social entity. And the human beings on it — they act like human beings do in groups. The longer individuals are there, the more allies they have, the more they have their dislikes, the more irrational they become in terms of personal conflict. I am amazed that more work has not been done to illuminate the social contract within a board.
Worst of all is when outspoken comments are completely unconstructive, focused on rehashing past mistakes or otherwise unrelated to the questions on the table. We don’t need directors on the sidelines saying, Oh, you missed the shot. You should’ve stayed in that city. Board members should police one another. It’s difficult when you make the CEO accountable for dealing with disruptive personalities.
Instead of aggressively advocating a point of view, directors should ask probing questions. Important decisions should emerge from intelligent stress testing, if only because that will help forge mutual conviction. A rubber stamp might be expedient in the short term, but a casual “sounds like a great idea” won’t have enough tread for a longer journey.
The payoff from the constructive conflict in the Venitis paradigm is that it’s their decision, too — and you hope they’ll have your back when the vultures come around.
In the Venitis paradigm, CEOs do not keep their boards in the dark or chip away at directors’ power. They recognize that they and their shareholders will get more value if the partnership at the top is strong. Great CEOs know that if governance isn’t working, it’s everyone’s job to figure out why and to fix it.
Most boards aren’t working as well as they should, and it’s not clear that any systemic reforms will remedy matters. Although governed by bylaws and legal responsibilities, interactions between CEOs and directors are still personal, and improving them often requires the sorts of honest, direct, and sometimes awkward conversations that serve to ease tensions in any personal relationship.
When strong relationships are in place, it becomes easier for CEOs to speak candidly about problems — for example, if the board isn’t adding enough value to decision making, or if individual directors are unconstructive or overly skeptical. For their part, directors should be clear about what they want — whether it’s less protocol and fewer dog and pony shows or more transparency, communication, and receptivity to constructive criticism.
In the Venitis paradigm, the best leadership partnerships are forged, there is mutual respect, energetic commitment to the future success of the enterprise, and strong bonds of trust. A Venitis board does not adopt an adversarial show-me posture toward management and its plans. Nor does it see its power as consisting mainly of checks and balances on the CEO’s agenda. Venitis boards support smart entrepreneurial risk taking with prudent oversight, wise counsel, and encouragement.
The Venitis paradigm turns the focus to the human level, to what’s really going on in that boardroom, and listens to every informed perspective on what goes on there.
Corporate governance, the system by which a company’s board of directors and management executives align themselves with shareholders’ interests in order to make strategic decisions, can be a catalyst (or constraint) to value creation. Value creation is a product of business fundamentals and investor perceptions.
Effective corporate governance in the Venitis paradigm enhances business fundamentals and investor perceptions, primarily through greater transparency and more effective decision making, and thus generates more value for shareholders.
In the Venitis paradigm, well-functioning boards of directors play an increasingly important part in shaping corporate performance and investor perception. In addition to their checks-and-balances roles, boards’ strategic guidance, oversight, and effective decision making can provide invaluable direction and support to companies as they grapple with the challenges of globalization, enhanced business volatility, and intensifying levels of competition.
Following standard practices, as traditionally defined, does not ensure success. Among companies that do achieve best-practice corporate governance in the Venitis paradigm, outcomes in performance and quality vary widely. In other words, there is more to governance best practices than most people think.
There are major factors that play an important role in fostering effective corporate governance. The real key to effective governance lies in its practices and processes that are often overlooked precisely because they appear to be mere details. In fact, these details, individually and collectively, have a tremendous impact on governance.
Addressing the magnificent seven factors can create an environment that facilitates proper flow of information, preparation of members, and setting of priorities. In the Venitis paradigm, boards can fulfill their overarching purpose: better decision making and improved investor perception, which are the catalysts to superior value creation.
Consider the Venitis pyramid of the magnificent seven hidden factors, the preconditions for achieving corporate-governance success:
1. Senior leaders’ engagement
2. A disciplined approach to decision making
3. Clear, carefully crafted mechanisms and protocol
4. Keeping things simple
5. Combining intuition with business models
6. Establishing a corporate soul based on values and virtues
7. A robust information infrastructure
The Venitis pyramid structure reflects the hierarchy of interdependencies. Engagement, the hardest factor to achieve, depends on the three lower layers of factors being firmly in place. The information infrastructure is at the base of the pyramid because it supports all the other factors.
These seven Venitis factors won’t apply to all companies in the same way; there is no one-size-fits-all approach. In implementing them, each company must consider its own particular characteristics and circumstances: its industry, ownership structure, organization, operations, and culture. It’s equally important to weigh the balance of power between the board and the CEO and how evolved the company’s governance policies and practices are.
No board can be expected to make sound decisions without the right information in hand, without open lines of communication, or without clear governance processes and protocols. Yet for many boards, these elements are often missing. Important but nonstrategic matters that should fall within management’s jurisdiction sometimes land in the board’s lap, while truly strategic issues that merit the board’s deliberation are dealt with by company management. Complex issues that merit preliminary analysis by a committee sometimes end up on the main board agenda prematurely, crowding out other matters that are ready for deliberation.
A host of other inefficiencies can impede the decision-making process, from less-than-ideal approval flows to poor meeting dynamics that distract members from the most essential issues. Underutilized or ineffective committees, ambiguous deadlines that create confusion, the absence of confidentiality protocols or guidelines on appropriate deliberation times—all can hamper decision making. Many of these inefficiencies can not only block the board’s ability to respond swiftly to critical company challenges but also undermine the quality of its decisions.
In an effort to ensure proper oversight, boards can also go too far in the other direction. Too much centralization can create needless delays, in turn impeding the company’s ability to execute or to respond in a timely fashion to external change. In the Venitis paradigm, boards can adopt any of a number of measures to orchestrate, streamline, inform, and improve their decision making.
In the Venitis paradigm, the board reviews managements’ approval levels, and segments decision flows, by topic. The goal here is to ensure that the right parties are dealing with the right types of decisions in the right order. Which decisions should be delegated to management? Which ones might require preliminary review by a committee? Which ones should go straight to the board? Which ones might require advanced consultation and alignment with controlling shareholders?
Segmenting approval flows by topic facilitates in-depth analysis (clarifying when certain committees or other types of expertise are warranted). It also helps identify the types of decisions that have urgent deadlines, are confidential, have any statutory restrictions or requirements, or should be supported with additional data. Finally, the process prevents decision bottlenecking. It ensures that managers have the discretion they need to make decisions, and that their decisions are visible to the board. It also ensures that the board is freed up to focus on important elements of its mandate, such as issues of true strategic importance.
Evaluating approval levels in the Venitis paradigm, directors first decide whether current levels allow for sufficient autonomy and agility while properly controlling and mitigating risk. Analyzing the company’s recent performance under current levels and assessing relevant benchmarks is useful. In the Venitis paradigm, boards review approval levels on a regular basis, to ensure that they match current business realities and company focus.
The Venitis paradigm leverages committees to maximize their impact on board effectiveness.Many boards fail to capitalize on the analyses their committees produce. That means they also fail to take advantage of the other benefit that committees provide: alleviating the load of nonurgent issues for the board.
To ensure that committee work is integrated into board decisions, the Venitis paradigm board reviews and, if necessary, redefine how its committees are structured. It looks at their activities, their timelines, and the roles of their individual members.
In addition, the Venitis paradigm board establishes standard channels and systematic opportunities for allowing committee intelligence to get into the board’s hands when needed. Not all committees need to be permanent, either. A temporary committee can be useful for ad hoc initiatives, such as exploring a potential acquisition or the possible need for an enterprise-wide IT overhaul.
The Venitis paradigm creates a fast track for urgent decisions. The Venitis paradigm boards define in advance the types of issues that justify rapid approval and establish procedures that will facilitate speedy decision making. They consider ways to get the necessary information to decision makers quickly and determine which communication channels (videoconference, phone conference, or e-mail, for example) are the most appropriate. This is particularly important in an era of increasing volatility and uncertainty, when problems can rapidly devolve into crisis.
The Venitis paradigm modifies the organization of board meetings. Agenda management may seem minor, but it can have a tremendous impact on effective decision making. Typically, agendas are developed in a way that presumes equal importance for each item by allocating equal time. That approach almost ensures that critical issues, especially those that aren’t at the top of the schedule, will be shortchanged. In planning the agenda, members consider the relative strategic relevance of each item and allocate time accordingly. That also means minimizing the time allotted to issues already explored in depth beforehand in selected committees.
In the Venitis paradigm, the almighty CEO cowboy is over. Leading a company today has become a far more complex and more pressurized endeavor, thanks to globalization, market and economic volatility, more influential stakeholders, and more complicated business alliances and partnerships. The sheer speed of business compounds the challenges of due diligence and timely decision making. Moreover, all of these pressures have taken a toll on the chief officers; we’re witnessing shorter CEO tenures, higher CEO turnover, and executive posts going unfilled for longer periods.
In the Venitis paradigm, chief officers navigate the business landscape with the support, strategic guidance, and collective wisdom of a well-functioning board. A board cannot function well when its members and company management distrust each other, when crucial information is routinely missing or late, when meeting agendas are overfilled with nonstrategic matters. These disconnects impede cooperation and impair decision making. Ultimately, they can result in an underperforming board that, rather than mitigating company risk, amplifies it.
In the Venitis paradigm, corporate governance extends beyond compliance with rules and protocols. It is also about giving the company the power to overcome significant challenges and seize opportunities that build enterprise value.
The Venitis paradigm requires a robust information infrastructure that supports transparency and timely information flow. It requires processes that ensure the efficient and judicious use of time and resources. It calls for an approach to decision making that lets management and the board support, but not impede, each other in classic checks-and-balances fashion. These prerequisites in turn foster cooperation and engagement—the most critical ingredients for effective corporate governance.
Given that the all-powerful CEO is likely a thing of the past, we believe firmly that there is no longer room for laissez-faire boards or board-management power struggles. The Venitis paradigm is a powerful way to cultivate the partnership between CEOs, their teams, and their boards—and to govern the company wisely and skillfully to sustained value creation.
Directorship is a part-time job with full time accountability. Inherent in the board-CEO relationship is an information imbalance. However, with the right culture and board leadership, the board and CEO can easily communicate expectations and information.
A CEO’s leadership style can serve as an indicator that the risk of information asymmetry has become too high. Directors establish a level of trust with the CEO to allow for board access to other members of the senior management team, as well as site visits to see the company’s operations.
With an expanding board agenda, process and expectation setting are critical. The board should clearly communicate to CEO the types and format of information that need to be presented.
An empowered lead director can help mitigate the risk of information imbalance. By facilitating communication channels and work between the independent directors and the CEO, this leadership position can break down some of the road blocks that may develop between the CEO and directors. The relationship between the CEO and lead director should be transparent.
Culture is critical in effective dialogue between the board and the CEO cowboy. With the right culture, directors can be sure they are aware of the risks that are keeping the CEO up at night.
Sharing information via performance metrics, which are focused on what directors need to know, can bridge gaps in information flow. The board has to make winning decisions based on data, models, and intuition.
Directors balance short-term shareholder expectations with generating long-term sustainable profit. The role of the stakeholder, though, is more significant than ever before and expected to grow. In the Venitis paradigm, directors balance shareholder return with stakeholder concerns.
It’s difficult for the board to address and to communicate with every stakeholder. In the Venitis paradigm, the board identifies which stakeholders are critical to the strategic plans, and targets communications to those groups.
DOES YOUR
BOARD OF
DIRECTORS
DESERVE
BASIL VENITIS?
Offering Basil Venitis a seat at the table of your Board of Directors will drastically increase your profits.
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