Archive for the ‘shareholders’ Category
Research in Motion (a.k.a. “RIM”, maker of the Blackberry) has been under pressure to split the role of CEO and Chair. RIM has been facing serious scrutiny of late, and questions have arisen in particular about whether the company needs new leadership. Splitting the role of CEO and Chair would be an awfully good start.
See this Globe & Mail story, by Janet McFarland: Shareholder calls for splitting CEO, chair roles at RIM.
A small investor in Research In Motion Ltd. …is anticipating big support for a shareholder resolution calling on the BlackBerry maker to split the jobs of CEO and chairman.
Mutual fund company Northwest & Ethical Investments LP has argued RIM co-CEOs Jim Balsillie and Mike Lazaridis should not also be co-chairs of the company’s board, arguing a “high performance” board needs independent oversight of management.
The story quotes Bob Walker, vice-president of Ethical Funds at Northwest & Ethical, as saying that keeping the two roles “has become standard practice, not just best practice.” More to the point, perhaps, is that it has become widely-recognized not just as standard, but as best. The board’s job is to oversee the CEO, and it’s hard to do that effectively if the CEO runs the board. (This was precisely the point of Friday’s blog entry on conflict of interest among mayors and chairs.)
You may well hear people point out that there’s no evidence that splitting the roles of CEO and Chair is beneficial, in the sense of increasing long-term shareholder value (or in terms of any other outcomes, for that matter). Fair enough. But to say that there’s no evidence is not to say that there’s no reason. Shareholders have a right to good governance, and that right doesn’t depend on concerete outcomes, any more than a client’s right to zealous legal representation does.
There’s another reason to favour splitting the chair & CEO. Even if such a split isn’t directly correlated with increasing shareholder value, it may well be correlated with other things that matter. My colleague Matt Fullbrook, of the Clarkson Centre for Board Effectiveness, puts it this way:
Since the early 2000s, splitting the Chair/CEO roles has become the norm in Canada, and with good reason: more than any other individual governance best practice, Chair/CEO split with an independent chair is highly correlated with adoption of other good governance practices and disclosure. That there is still push-back on splitting the roles is baffling.
Martin’s speech was basically a summary of the key ideas from his new book, Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL. (I mentioned Martin’s book a few weeks ago, in a blog posting called Business, Football, and Incentives.)
Here is a rough summary of what he had to say, paraphrased and condensed:
Prior to the mid-70′s, stock-based compensation for CEOs was rare. But starting especially in the 80′s, it became very common indeed. Martin traces the sea change to a famous paper by Michael Jensen and William Mecklin, called “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure” (PDF here). The basic idea at the time was that paying senior executives, and especially CEO’s, in company stock or stock options would align their interests with those of shareholders. Shareholders naturally want the value of stock to rise, and paying CEOs mostly in stock gave them a very concrete reason to want stock to rise, too.
It was a fine theory, says Martin, but it didn’t work out well. If you compare the era of stock-based compensation to an equivalent period before, you see that returns went down about 15% and stock volatility went up about 15%. Those definitely aren’t the kinds of results that shareholders were looking for.
And yet somehow people still cleave to the idea that stock-based compensation aligns interests. Why?
It’s clear enough why CEOs themselves are fans of the system. The reason, according to Martin, is rooted in the fact that stock prices only reflect the market’s collective expectations about a company’s future performance. That means in order to boost stock prices (and hence their own compensation) CEOs merely need to boost expectations. So, says Martin, that’s what CEOs have learned to do: manage stock analysts’ expectation, rather than managing actual performance. If analyst expectations are low when stock options are granted, and high when they get cashed out, a CEO stands to make a lot of money, independent of what that variation means in terms of actual performance.
But of course, says Martin, CEOs have realized that you can’t play that game for very long. So, they learned to look for opportunities to play a hit-and-run version of the game: get in, play hard, and cash out. That, he says, is the real reason why the average tenure of CEO is so short these days.
Is this malfeasance on the part of CEOs? Not really, says Martin. It’s just CEOs doing what they are payed — incentivized — to do.
Now, says Martin, compare this situation to the way quarterbacks are payed in professional football. Professional quarterbacks, he says, are paid for real, on-the-field performance. Additionally — and this is crucial — they are forbidden from profiting from outsiders’ expectations of how they will perform, i.e., from gambling on the outcome of the games they are playing in. Why? Because professional football leagues realize that letting quarterbacks gamble would give them all kinds of perverse incentives. The corporate world, it seems, has something important to learn from the world of pro football when it comes to incentivizing key personnel.
In the corporate world, says Martin, the only ones with something to gain from having stock-based executive compensation are CEOs and hedge funds. Both, he says, benefit from volatility of stock prices.
Martin’s prescription: performance-based compensation is fine. But don’t reward CEOs based on stock prices. Reward them based on real performance, in terms of something like earnings or sales or market share — different systems will make sense for different companies with different strategic objectives. But the point is to reward them for something more real than merely meeting the expectations of analysts.
It’s a provocative thesis, and a bold prescription. To say that stock-based compensation is “standard” is an enormous understatement. And Martin acknowledges that change, if it comes at all, will not come quickly. But given how widely-agreed-upon it is that current modes of compensation are not working, bold prescriptions may just be what is in order.
I’m fond of sports analogies in helping to explain key issues in business ethics. In both business and sport, a useful competitive endeavour is constrained by a set of rules for the benefit of both players and spectators.
According to Roger Martin, Dean of the Rotman School of Management (where I’m currently a Visiting Scholar) the comparison is not just explanatory, it is prescriptive. According to Martin, for example, CEOs Should Be More Like Quarterbacks. In particular, he says, CEOs should be more like quarterbacks in the way quarterbacks stay focused on the real goal of the game — winning — rather than on meeting the expectations of those who speculate on the outcome of the game from the outside. QBs focus on real performance, measured in yards and touchdowns, rather than on performing well relative to the expectations of bookmakers. Likewise, Martin says, CEOs should focus on their companies’ real performance, rather than on how they perform relative to the expectations of stock analysts.
It’s tempting to run wild with sports metaphors, as the comments under Martin’s blog demonstrate. But we should not be tempted, just because we see one useful comparison, into thinking that CEOs should be like quarterbacks in all ways. You need to make the argument, on a point-by-point basis. Indeed the power of the comparison lies in abstracting away the ways in which CEOs and quarterbacks are not, and should not, be alike.
It’s also worth noting that Martin doesn’t think that the change in CEO behaviour that he advocates is going to happen magically, or even as a result of his own advice and efforts at persuasion. No, Martin is clear that CEO behaviour is only going to change in response to changes in incentives — in other words, changes in how they are paid:
…compensation is largely based in the expectations market in business and is strictly based in the real market in football. CEOs have a large portion of their compensation based on the performance of their company in the stock market, so CEOs spend their time shaping and responding to expectations. Quarterbacks have no part of their compensation based on the performance of their team against the point spread, so they focus completely on winning games.
Of course, that simple analogy needs to be fleshed out. Just what counts as “winning” in business, for example? And why are the opinions of external analysts such a bad way of measuring corporate performance? And finally, what would it look like to reward CEO’s for something other than improved stock performance, and would that lead reliably to better CEO performance on all dimensions, or just some?
(The ideas in Martin’s blog entry are drawn from his new book, Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL. Watch here for more comments on the ideas in that book in the coming weeks.)
Naturally, when any organization suffers unanticipated expenses, it’s going to have to find ways to make up the shortfall in its budget. That’s exactly what happened to Ontario Power Generation (OPG), the provincially-owned power company responsible for generating about 70% of all the power consumed in the Canadian province of Ontario. A legal battle with customers ended up costing the company nearly $20 million. So, where did the company turn to recoup that amount? Well, to its customers, of course.
Here’s the story, via the CBC: Ont. electricity rates expected to rise next week
Electricity ratepayers in Ontario, already reeling from soaring prices, should brace for more increases.
The Ontario Energy Board agreed Tuesday to let utilities raise rates to recover $18 million they paid in fines and legal costs after charging consumers excessive interest on late payments….
Now most companies could only dream of passing along such costs to their customers. Some might even succeed. But most wouldn’t. Most would be hindered by the fact that, if they raise the prices they charge to customers, customers would simply buy from someone else. But electricity in Ontario (as in most places) is a monopoly: an organization called Hydro One has a monopoly on distribution of electricity throughout Ontario, and the power it distributes is produced by a small handful of organizations, the most significant of which by far is OPG. So, with the consent of the Ontario Energy Board (the relevant regulatory agency) all OPG has to do is raise its prices, and the company’s customers end up paying for the consequences of its legal tussle with…the company’s customers.
I don’t know much about the original lawsuit, but I do know that this was a predictable result of it. And that puts customers of utilities in a strange position. Sure, customers can sue the a utility when they screw up, but all the utility is going to do is turn around and raise your rates to get the money back out of you.
Now, just to be clear, I generally have nothing against this sort of monopoly. Electricity distribution is what economists call a “natural monopoly.” It’s crazy to have multiple competing sets of power lines running down to street. And, for that matter, it might well be crazy to let many multiple competing companies all run nuclear power plants (OPG runs several of those). But at any rate, it’s worth recognizing the effect that this monopoly (or quasi-monopoly) situation has in the event that the company screws up (say, by overcharging customers). The expenses incurred are entirely likely simply to be passed along to their captive customers.
By the way, Ontario Power Generation (whose only shareholder is the government of Ontario) had a profit of $333 million for the 4th quarter of 2010.
Thanks to NW for the story.
“Insider trading” is one of those phrases that most adults have heard (at least on the nightly news), but that relatively few understand. (Perhaps the most famous case: Martha Stewart was originally charged with insider trading in the ImClone case.) I imagine few people even know what it really refers to. Well, it refers to situations in which corporate “insiders” (executives, directors, etc.) buy or sell their company’s stock on the basis of significant corporate information that is not available to the investing public more generally. (For more details, see the Wikipedia page on insider trading.)
But even if we don’t all know just what insider trading is, we all know insider trading is bad, and must be stopped. Right? But it’s hard to stop something that’s hard to define. In that regard, see this nice piece by Steve Maich, Editor of Canadian Business: “Chasing our tails while we chase insider trading.”
In case you hadn’t noticed, we are in the midst of a crackdown. Or rather, another crackdown. The crime du jour is an old favourite: insider trading….
There are obvious benefits to these shows of regulatory force. Seeing hedge fund managers and lawyers in handcuffs not only produces a nice dopamine rush, it’s also meant to demonstrate the integrity of the capital markets. But the costs are frequently overlooked. Like most crackdowns, this one seems likely to deepen cynicism, erode confidence and lob more grenades at shell-shocked markets….
Maich is undertandably cynical about these enforcement efforts:
Despite the periodic efforts of regulators to stamp it out, insider trading runs as rampant as ever, and that isn’t going to change. This is in part because it’s notoriously difficult to prove, but also because we have never definitely solved the fundamental puzzles at the heart of this supposed crime….
It’s worth adding that there is genuine disagreement over just why insider trading is unethical. (Some people even think it’s not unethical at all, because the executive who trades on “inside” information ends up indirectly bringing that information to the market, rendering the latter more efficient.) And if we’re not entirely sure why it’s unethical, it makes it that much harder to figure out in which cases it’s unethical.
The only scholarly article I’ve read on the ethics of insider trading is by Jennifer Moore, and is called “What Is Really Unethical About Insider Trading?”* Moore looks at a number of arguments against insider trading — arguments rooted in fairness, in property rights, and in the risk of harm to investors — and finds most of them lacking. Moore ends up arguing — plausibly, in my view — that the real reason insider trading is unethical is that it jeopardizes the fiduciary relationships that are central to business. If insider trading were permitted, that would put corporate insiders in a conflict of interest. Basically, the interests of corporate insiders would stop being well-aligned with the interests of the shareholders they are supposed to serve. And if the interests of corporate insiders aren’t aligned with the interests of shareholders, then people are much less likely to be willing to buy shares (i.e., to invest) in companies. And that wouldn’t be good for the firm, for its shareholders, or for society in general.
*Jennifer Moore, “What Is Really Unethical About Insider Trading?” Journal of Business Ethics, Volume 9, Number 3, 171-182.
The question of what a company’s social obligations are is an interesting one, and a vexed one. Unfortunately, the question is complicated by the fact that the very term “Corporate Social Responsibility” (“CSR”) has come to be associated with a particular view about the right answer to that question. As I’ve argued here before, the term “CSR” is now (regrettably) typically used to refer to the particular point of view that says that companies have an obligation to contribute socially, beyond the contribution they make by providing a valued product or service, by providing jobs, by providing investment opportunities, and by paying taxes.
That point of view was preemptively (but, to many, unconvincingly) criticized by economist Milton Friedman, in his famous 1970 article The Social Responsibility of Business is to Increase its Profits. Friedman asked whether it made sense to say that a corporation (or rather, a corporation’s management) has responsibilities to engage in such pro-social activities as:
- keeping their prices low, in order to fight inflation;
- spending more than required by law to reduce pollution;
- hiring the hard-core unemployed (rather than simply focusing on hiring the most-qualified candidates).
Oversimplifying somewhat, Friedman argued that a corporation’s managers have neither skill-set, nor the obligation, nor indeed the right, to use shareholders’ money for such objectives. What they ought to do, according to Friedman, is to stick to what they know best — which also happens typically to be the job they were entrusted to do, namely to make profits for shareholders within the boundaries of law & general ethical rules.
Here are 2 modern examples of opportunities for companies to do business in a way that is explicitly aimed at positive social outcomes:
- Pharmaceutical companies have choices about how to focus their research & development efforts. For example, they can focus their efforts at producing lifestyle drugs (for things like erectile dysfunction or hair loss), or they can aim at producing “me-too” drugs in categories that are already well supplied (e.g., ), Or they can focus on cures for so-called “orphan” diseases. Or they can search for new antibiotics in response to the growing problem of drug-resistant infections. The latter would meet a real social need. I don’t know how promising such lines of research would be, nor how lucrative. In the absence of such information, could we still say that pursing the development of new antibiotics is a social responsibility of drug companies?
- With U.S. unemployment rates just below the double-digit mark (and Canada’s just slightly lower), governments are looking to industry (and sometimes to particular industries, such as biotech) to boost employment. And some people are liable to point to a social responsibility on the part of corporations to do some hiring. Certainly, people are prone to call it socially irresponsible when profitable companies lay off employees. But then, employment for its own sake is unlikely to be good for a company. If employees aren’t needed, then hiring them (or keeping them) is liable to reduce profits, and indeed liable to reduce the viability of the company as an entity that produces all kinds of benefits for a range of stakeholders.
Whatever you think of such purported social responsibilities, one thing is clear. If they really are responsibilities, they are at very least genuine examples of social responsibilities — responsibilities to promote the interests of something like society as a whole (as opposed to the interests of one particular stakeholder, like customers or employees).
“Corporate governance” is the term used to refer to the policies and processes by which a corporation (or other large, complex institution) is controlled and directed. It refers especially to the way power and accountability flow between shareholders, boards of directors, CEOs, and senior managers.
For most corporations, the basic governance structure is this: shareholders vote for, and hence empower, a board of directors, who then have a fiduciary responsibility to look out for shareholders’ interests. The board hires a CEO, who is accountable to the board. The CEO (sometimes with input from the board) hires a management team, and so on. At each step, there is a flow of power down the chain (from shareholders through to front-line employees), and a flow of accountability back up that chain. And there are all sorts of rules — including various policies and principles of good governance — that establish how that power and accountability is to be implemented. There will be internal rules, for example (partly determined by relevant corporate law), about how board elections are to be carried out. There are also governance principles that apply to things like the inclusion of external, “independent” directors on the board.
In case it’s not obvious, I’ll say it explicitly: corporate governance is out-and-out a matter of ethics. It is about who is responsible to whom, and for what, and under what conditions.
Now, to an investor, governance might look first and foremost like a matter of economics: no one particularly wants to invest in a poorly-governed company. And governance is also legal matter (for example, the Sarbanes-Oxley Act of 2002 includes a number of requirements about corporate governance). Governance is properly a legal matter because (at least arguably) shareholders need protection from unscrupulous or merely lazy boards of directors and executives, and because the public interest is at stake when large companies are mis-governed. Enron used to be the prime example of poor governance practices having a devastating effect on shareholders and the broader public. These days we could probably look to a few major financial institutions for object lessons in the ill effects of bad governance.
But even where the law is silent, governance remains important: regardless of whether you think in terms of a narrow, shareholder-driven, profits-first perspective, or instead in terms of a broader ‘stakeholder’ approach, you simply have to agree that the way decisions get made, and the interests that corporate policies tell decision-makers to serve, are ethically important matters.
My mind is on governance a lot lately, not least because I’m currently a Visiting Scholar at the Clarkson Centre for Business Ethics and Board Effectiveness (at the University of Toronto’s Rotman School of Management).
While I’m at Clarkson, I’m helping out with the CCBE blog. The blog is focused primarily on governance and board effectiveness, but in most cases the ethical implications of those issues are pretty clear. Today, for instance, the blog features a posting about changes in the way boards of directors are elected — and how at last some companies (including one Canadian company, Linamar Corp.) have been slow to catch on. Here’s the blog entry: Trend Watch: How are Directors Elected?
Corporate Governance books currently on my bookshelf:
In the original Wall Street, Michael Douglas’s character, Gordon Gekko, is a corporate raider — essentially, he buys up underperforming companies, breaks them up and sells their parts at a healthy profit. What drives him? Greed, pure and simple. In one scene, Gekko appears at the annual shareholders’ meeting being held by Teldar Paper. Gekko owns shares, but wants more. He wants control of the company, though his motives for doing so are hidden. It is there that he delivers the speech that includes the movie’s most famous line. “Greed,” he tells the shareholders of Teldar, “is good.”
That line is the only thing a lot of people alive in the 80′s remember about Wall Street. And that’s a shame.
Here’s Gordon Gekko’s famous “Greed is good” speech, in its entirety:
Teldar Paper, Mr. Cromwell, Teldar Paper has 33 different vice presidents each earning over 200 thousand dollars a year. Now, I have spent the last two months analyzing what all these guys do, and I still can’t figure it out. One thing I do know is that our paper company lost 110 million dollars last year, and I’ll bet that half of that was spent in all the paperwork going back and forth between all these vice presidents. The new law of evolution in corporate America seems to be survival of the unfittest. Well, in my book you either do it right or you get eliminated. In the last seven deals that I’ve been involved with, there were 2.5 million stockholders who have made a pretax profit of 12 billion dollars. Thank you. I am not a destroyer of companies. I am a liberator of them! The point is, ladies and gentleman, that greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA. Thank you very much.
The first thing to note about this speech is how little of it is actually about greed — roughly the last third of the speech. The first two thirds is a critique (disingenuous, as it happens, but not therefore off-target) of the complacency of overpaid corporate executives. Gekko is advising Teldar’s shareholders that the people responsible for protecting their interests — Teldar’s executives and Board — have been doing a bad job.
How does that first part relate to the final third of the speech, the part about greed being good? Well, it’s worth noting that when Gekko first uses the word “greed,” he does so “for lack of a better word.” And Gekko, one-dimensional character that he is, probably does lack a better word for it. For him, it really is greed — the unseemly and excessive love of money. But Teldar’s shareholders don’t need personally to embrace greed in the Gordon Gekko sense. All they need to do is to see that their interests are not being served well, and to understand that Gekko’s own greed is likely to serve them better: he wants to make a killing on the Teldar deal, and if they let him do so, they’ll all make a little money themselves, along the way. His greed is good for them.
Is Gekko’s greed a good thing over all? Well, Gekko says nothing, in his speech, about the interests of other stakeholders in Teldar Paper, stakeholders such as the company’s employees for example. If Gekko breaks up the company, shareholders may benefit but employees will lose jobs. That’s a bad thing, but it’s also sometimes inevitable. Not all companies should stay in business.
No, greed is not good. But the point — the grain of truth in Gordon Gekko’s Machiavellian speech — is that if shareholders allow executives and Boards to operate inefficiently, rather than using what little power they have to improve their lot, then they are suckers, being taken for a ride. And there’s no particular virtue in that.
A divorce is a very private thing, except of course when it isn’t. And an employee’s (or executive’s) private struggles are, well, private — except when various kinds of business analysts start taking notice of those struggles.
Case in point: the bitter lawsuit over the terms of the difficult divorce of Elon Musk, one of the co-founders of PayPal and current CEO of Tesla Motors. For an outline of why the divorce resulted in a lawsuit, see this blog entry, by Jeanette Bicknell: Challenge to Confidentiality in Mediation? Basically, Musk’s ex-wife, Justine, is challenging the terms of the divorce settlement, and it looks likely to be a long, drawn out court battle.
The whole thing is a sad event for the former couple (and their 5 children) but it is also presenting problems for at least one of Mr. Musk’s companies, Tesla. See this piece from auto-industry website FutureCars: Could Elon Musk’s Divorce Affect Tesla’s IPO?
Sources are saying that the upcoming Tesla Initial Public Offering will be for between $1 and $1.5 billion or $10-$12/share, but all of this could be in jeopardy because of CEO Elon Musk’s pending divorce.
So the problem here is more than just the worry that an ugly personal battle is. And it’s not just the worry that Musk’s personal issues are a distraction from his management duties, though that has been suggested. No, according to the FutureCars story, Musk’s bitter divorce could have very serious implications for Tesla Motors, particularly if the court decides that Mr. Musk has to give some of his stock portfolio to his ex-wife:
If [Musk] did lose a large shareholding, that would default Tesla’s recent Department of Energy loan and could cause the S-1 filing for IPO to go in the round file….
So, the question for discussion: do investors in Tesla have the right to tell Mr. Musk to get on with it and settle the lawsuit with his ex-wife? Are investors (or employees, for that matter) essentially stakeholders in the Musk vs Musk court battle? Or is that an entirely personal matter, and none of investors’ business?
p.s., for those of you worried more about Mr. Musk’s emotional state than the financial well-being of his companies, fear not: he just recently celebrated his marriage to Hollywood starlet Talulah Riley.
The shareholders of a public company are sometimes said to own the company. That’s not literally true, for lots of reasons. (See: Do Toyota’s Shareholders Own the Company?) What shareholders really own is the right to part of a company’s profits (if any) after all of its other expenses are paid. At any rate, the fact remains that shareholders are crucially important, and they are in many ways vulnerable. The legal rights of shareholders are relatively few, and relatively weak. That’s what makes corporate governance so important. Shareholders elect the Board of Directors, and the Board of Directors is responsible for hiring the CEO and helping set the overall strategic directo of the firm. For most shareholders, there are precious few ways to interact with, let alone influence, the Board of Directors. The Annual Shareholder Meeting is critical, in that regard.
That’s what makes it so striking when any company degrades its Annual Shareholder Meeting in the way Symantic did this year by switching to an all-virtual, audio-only meeting. See this opinion piece, by Gretchen Morgenson, for the NYT: Questions, and Directors, Lost in the Ether. Check out this juicy bit:
…because the Webcast provided no video, shareholders may not have realized that several directors had not bothered to attend the meeting, even virtually. When asked about directors’ attendance, [Symantec spokeswoman] Ms. Haldeman said 8 of the 11 showed up.
Attending annual meetings seems a pretty basic requirement of a director, don’t you think? Sure, such gatherings may seem a corporate equivalent of root-canal therapy, but a duty is a duty. Directors are paid for their service, after all, sometimes very handsomely. According to Symantec’s most recent proxy materials, directors get around $250,000 a year in cash and stock.
So which directors had neither the time nor the inclination to log on to their computers last Monday to hear from the shareholders they have an obligation to represent? Ms. Haldeman refused to identify those who were AWOL.
Now, it’s worth pointing out that the 3 directors who didn’t “show up” could well have had very good reasons. But if that’s true, Symantic’s shareholders deserve to know it. The little power shareholders have can only be exercised effectively if boards of directors take their duty of accountability seriously.