The Biggest Joke in Corporate America

October 23, 2008 · Posted in Big Business Ripoffs, Political Issues, Things to think about 

In theory the Board of Directors of a corporation is supposed to look out for the shareholders, supposed to rein in excess risk taking, excessive executive compensation and act as a check on the strategic decision making of the executive managers.

In practice, this is the joke.  Unfortunately, it is not in the least bit funny.

As someone who believes in capitalism I have to point this out.  The system is not working.

An appointment to the Board of Directors of a publicly traded corporation is typically made through a nominating process over which the executive management has tremendous (and often times absolute) influence.

As a result of this, Board membership has become primarily a lucrative “side job” wherein directors offer little oversight lest they be seen by the CEO as a threat and thus excluded from the decision making process.  A director trying to promote a view different from that of the CEO is often handled much the way an opponent in a legislative body is – the CEO will work through the rest of the Board to isolate that member and ultimately to have him/her removed as soon as the term expires.

I have experience with Boards through my professional dealings – both from within corporations and as a shareholder who has participated in activist campaigns.  I can tell you from experience that this is the case.

What can we do about it?

I believe that free, working markets are the best means of allocating capital.  The key word in the last sentence is “working” markets.  For a market to work, the checks and balances within the system must work.

The Board of Directors is a critical check in the system and it is not working.

To make it work I believe that legislation at the national and state level must be enacted to do the following:

1) Change the nomination process for Boards of Directors.  The nomination process should be driven by shareholders through an independent director on the Board that has no affiliation with the company outside his / her role as independent director.  The executive management should not have influence over this process

2) State pension funds which control an enormous amount of capital and shares of American publicly traded companies must be compelled by their state legislatures to take a more active role in governance of the companies in which they invest the retirement savings of state public employees

3) Board members should be required to have a meaningful amount of their net worth in the Company over which they are governing.  If a director worth $100 million owns $1 million of stock in that company or, more likely, owns no stock outright and is on the Board with the intent of getting options as part of his/her package they have no “skin in the game”.

I think directors of major public corporations should be required to have 3-5% of their liquid net worth in the company on whose Board they serve.  A more meaningful level of “skin in the game” will make directors take their role as watchdog more seriously.

4) Bonuses to executives should be paid based on rolling multi-year performance of a company.  Paying a bonus based on one year of performance inserts to much randomness into the system.  Consider this, a mediocre CEO happens to be in the right business when some major trend develops or economic boom.  As a result the profits surge for a year or two.  The executive hires a consultant to justify an enormous paycheck based on this performance, which of course the executive takes credit for.  In fact, the performance was essentially random and had little to do with the executive if anything at all.  This is the problem with huge cash bonuses and stock options.  Executive compensation should be based on stock that an executive must hold for years after he/she leaves the position and a rolling multi-year performance criteria with respect to cash compensation.

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Comments

5 Responses to “The Biggest Joke in Corporate America”

  1. she on October 23rd, 2008 1:55 pm

    No doubt. So often being nominated as a director to a board is more of a status than a responsibility. To be able to say they have “Celebrity A” and “Politician X” on a Board is much more marketing than actual strategery.

  2. Larry on October 25th, 2008 9:14 pm

    I respect the concept, but how are you going to get shareholders to assist and pension funds tend to be hands off if there is a chance they could upset the apple cart. In short, I totally agree, but the battle can not be won without strong government oversight, and if SOX can’t make them feel accountable then I am not sure what legislation is will take to get their attention.

  3. we on October 28th, 2008 4:16 am

    Larry, I agree with you that this is an ideal and difficult to achieve in practice. I believe it could be done through legislation. Unfortunately, I think that due to the failures in corporate America in recent decades the legislative response will be over the top in ways that, in the long run, will equally impede the proper functioning of the market. I just felt I needed to lay out there this failing of the system.

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