Corporate governance is a myth

The concept of corporate governance implies consistent and effective laws, methods, and metrics for governing our nation's public companies. The sad fact is that there is no such thing. It's a myth. Here's why:

People talk about the fiduciary responsibility of boards of directors. What that means, in plain speak, is that boards are supposed to:

1) Hire and fire the CEO and appoint other corporate officers
2) Compensate the CEO and other corporate officers
3) Oversee corporate strategy
4) Represent shareholders in the transparent and effective governance of the company

As an ex-officer of several public companies and as a consultant, I've been involved with lots of boards, executive staffs, investment banks, VCs, corporate attorneys, and the like. At least in my experience, boards don't operate the way they're supposed to.

Let's take the last point first. Shareholders are offered a slate of directors and a handful of issues to rubberstamp. That means they have two choices: accept or reject.

Now, let me ask you this. If your spouse or doctor says, "Here's my recommendation, take it or leave it," what do you do? That's right, you take it. Is it the best thing for you? Who the heck knows? You had a gun to your head so you nodded up and down.

Also, who do you think comes up with those director candidates and other issues to vote on? That's right, the CEO and certain other corporate officers. Some companies employ executive search firms for new directors, but the CEO and certain other corporate officers still oversee the selection process.

Moreover, if you're like most investors, you gave up your voting proxy long ago by investing primarily in various funds: mutual, hedge, exchange-traded (ETF), whatever. You're represented by so-called institutional investors. And their strategy is simply to diversify. They spread their investments around to minimize the effect of any one company. If they don't like what's going on there, they take their money out and put it somewhere else. Case closed.

So the whole voting thing is largely perfunctory.

Then there's the oversight function. Boards typically only see presentations that are scrutinized, sanitized, and polished by the executive management team. During board meetings and in individual meetings, directors offer perspective and advice, but the management team is not obligated to follow that advice or even to close the loop. There literally is no accountability other than, you guessed it, compensation and termination.

All the executive compensation plans I've seen were actually developed internally, albeit sometimes using external or objective data. Then they're ratified by the board's compensation committee, but that's just the rubberstamp thing again.

Also, boards consist mostly of current or retired executives chosen by the CEO, as well as VCs and other investors who've been on-board forever. Whom do you think they sympathize with?

Sure, if executive staffs and CEOs fail to meet their objectives, they may not get paid as much, but as I said, that's essentially a self-governing function.

As for hiring and firing CEOs and appointing other corporate officers, let's start with the last part first. Sometimes directors interview executive officer candidates, but the CEO has the final say on who to hire. Again, the board just rubberstamps the appointment.

As for the CEO, many companies have only had one. That aside, yes, boards hire CEOs. But it's not as if shareholders have anything to do with that, since they just rubberstamp the directors and the CEO, as we discussed above.

And, for all the reasons already stated and a host of others--some of which are actually in the best interests of shareholders, like disruption to the company and its business, that sort of thing--boards are reluctant to terminate CEOs. In the rare event that they do, it's no skin off their back if the CEO has a sweet termination package, especially since that's the norm in corporate America.

So there you have it, all the reasons why most public companies are, in practical terms, primarily self-governed.

How about the Sarbanes-Oxley Act of 2002, aka SOX? Let me tell you about SOX. Enron, WorldCom, and Tyco happened. Your elected officials saw an opportunity to get brownie points, so they got involved and came up with this gem of legislation. Sure, there are one or two good things about it, but on the whole, SOX goes way overboard.

First, SOX compliance comes out of shareholder's pockets. Second, SOX taxes our nation's ability to compete in the global marketplace. Third, there's no clear evidence that SOX would have prevented Enron et al. It certainly didn't prevent 1,300 corporate fraud convictions since 2002.

As for so-called activist investors like Carl Icahn, certain hedge funds, and the like, they're just big, short-term investors who are in it for themselves. Whether their efforts help long-term investors, institutional investors, or the company itself, is ancillary, as far as they're concerned. In some cases they help, in others they hurt, and in all cases they and their proxy battles are huge distractions for the management team and disruptive to the company.

What does all this mean? It means that our system of corporate governance, if there even is such a thing, is dysfunctional at best. What can you do about it? Diversify. It's that simple. I know, diversifying is a big pain in the butt and you don't do it as much as you should. That's fine. But when the next bubble bursts or the stock you've bet your retirement on collapses because somebody committed fraud, don't blame it on corporate governance. Just pick yourself up from the rubble, dust yourself off, and put everything you have left in ETFs. You'll sleep better at night.

[ghostofitpast]

This strikes me as one of those examples where you believe what Wikipedia tells you at your own peril. The governance of a corporation is no different from the governance of a country. As we have seen in the latter case, the extent to which the POLIS are adequately and fairly represented by the governmental machinery of the country in which they reside runs the entire gamut from aspirations of an ideal republic to the most repressive forms of totalitarianism. Just because a corporation goes public does not mean that its governance structure should favor the former extreme over the latter. If you do not like the way a public corporation is governed, don't invest in it; but don't complain when the performance numbers of the corporations in which you DO invest are less than spectacular!

[The_Decider]

Is this a bad thing?

Most investors are looking for a quick buck and if it takes harming the company to do so, they don't care.

[chash360]

Yes this is a bad thing...Q: Why not hurt all of the public companies, in fact liquidate them to line shareholder pockets? A: we would have no more industry at all, the economy would collapse entirely.

The worst thing going right now is the insatiable greed that is occuring, it does not matter if you make a profit in your business, if you do not grow and continually accerate that growth, the BOD's on behalf of shareholders will cut you off. Of course accelerated growth can not be maintained indefinately in any business, but that does not matter to them. They want to see this growth to convince people to invest, thus inflating the stock value so they can sell that stock and make money for themselves. They do not care about the business, the customers or employees of that business, or the products or services of that business.

The worst thing a company can do in this time of greed is become publically traded, it seals the companies doom. If you care about your business, about your customers, employees, products and services, don't go public. Because the BOD will eventually make the decisions to benefit stockholders and stock price, sacrificing your business and ability to do business.

All of the off-shoring of jobs, the layoffs, the outsourcing, and complete debasement of the US manufacturing base has been done by these BOD's to show growing profits, increase stock price and and benefit stockholders. Nevermind the fact that you no longer are doing any real business, its all outsourced to someone else. Q: How are people going to afford these products and services when they no longer have a job? A: They won't, which will drive more cutbacks, layoffs and off-shoring of jobs, to keep those numbers looking good for the stock market.

Remember one simple fact: Only value added work creates real value. Stockholders do not create value, they do not do any actual work for the business whatsoever. In the long run, with current greedy philosophies of BOD's, they only serve to leech off the work of a business. All stockholders eventually intend to sell their stock for a profit, they do not care if the value is actually there.

These are tough economic times, for employees of publically traded companies, because they are seen as nothing more than a cost to stockholders, when they could be paying a fraction to some 3rd world worker instead. Again stockholders and BOD's do not care about things like quality, or employees, or customer saticfaction, they care about numbers that mean money in their pocket.

[Elfin1dw]

This sounds very familiar to 'corporate democracy is a myth' on the www.icahnreport.com. All readers of this post should read that one as well.

[BoardExpert]

To get good governance you need good people as well as good systems within the business and a good legal framework. ?Most? investors in my experience want the company to prosper; that is how they get their rewards. Most of the boards that I work with are building long term value for their shareholders. Very few directors are interested in short term timing or ?pump and dump? schemes.

As a shareholder you have the right to elect directors and to query, at the shareholder meeting, whether the directors offered are actually suitably qualified to safeguard and enhance the value of your investment. Few shareholders use this right wisely and insist on qualified directors. A qualified professional director, reliant on director fees to make a living, will not allow management to ride roughshod over the rights of shareholders and will be diligent in undertaking his or her duties.

Governance is only a myth if directors don?t make it a reality!

For a full discussion of this issue see my post on the Audit Trail at http://www.approva.net/audittrail/ or my website at www.mclellan.com.au