Poor financial returns, low stock price, a board that hasn’t changed for over a
decade—these are some of the board characteristics that attract activist
investors. To make the case for board change, the activists will attempt to
draw a correlation between poor financial and operating performance with poor
oversight as a way to blame the board.

In a Blank Rome LLP webinar, partner Keith Gottfried warned participants not to be
that board. Conduct your own evaluation of the board’s vulnerabilities: Has the
board failed to hold management accountable? Is the compensation excessive?
Does the board lack sufficient industry experience? Has the board explained how each director is qualified?  Is the board lacking in diversity? Is the board sufficiently independent?  Is there a perception that the board is not “fully engaged”?

Paul Schulman of MacKenzie Partners and Chris Cernich of ISS also participated in the webinar.

Shareholders are now part of the governance dialogue.  Not only must the board carry out its duty of care to represent all shareholders, but they must convey in
board structure and leadership how the board governs.  The webinar together with the presentation is posted on the Blank Rome website.

In their excellent paper posted on the Newport Board Group website, Gary Kunkle and Mark Rosenman discuss the need for independent directors at private, growth-oriented companies.

Entrepreneurs, they say, “need to look beyond day-to-day operational firefighting.  They need the timeliest, savviest, most reliable counsel about markets, trends and companies.” The authors provide a helpful guide to the natural stages of enlisting advisory help.  Sure, the entrepreneur can go it alone, but he or she is likely to fall victim to “myopic decision-making to which nearly all closely held companies are prone.” A private company may seek independent board members when it needs liquidity but the right independent advisors can bring so much more to emerging companies. Not only do independent directors help the entrepreneur to develop stronger, more professional management, but they often oversee the creation of financial and operational controls. The presence of talented business men and women serving as independent directors also sends a message to world that the CEO entrepreneur is confident enough to challenge his thinking in growing a stronger company.

In its webinar on CEO Succession and Compensation co-sponsored by NACD, Pearl Meyer & Partners Yvonne Chen and Matt Turner discussed the growing visibility and importance of the CEO succession process and effective compensation practices. The issues abound, whether it’s the board’s oversight role in developing strong internal candidates for the job, having an immediate successor in place in case of an emergency or keeping those “runner ups” engaged in the company if they are not selected for the post.  High profile CEO succession failures have a demonstrated negative impact on the company’s stock and create a host of challenges related to employees and public relations.  Moreover, it is clear that when a company goes “outside” to find a new CEO, it’s more costly—79 percent of those CEOs who are paid more at target than the prior CEO are external hires.

One of the questions posed during the webinar was about the performance of internally developed CEOs versus externally recruited CEOs.  A recent study by the Kelley School of Business of Indiana University, led by Fred Steingraber, directly addresses this question.  An article outlining the study’s findings (co-authored by me) appeared in a recent issue of Corporate Board Magazine. The study, which details the superior performance of internally developed CEOs, examined the leadership of the most successful non-financial S&P 500 companies from 1988 through 2007. The 20-year duration was critical to the study because it minimized distortions of performance that could have occurred over shorter time spans of three, five or even 10 years. In addition, this two-decade period was characterized by different economic cycles, globalization, dramatic technology advances, shifting consumer preferences and changes in leaders competing under a wide variety of conditions.

In our article, we summarized how this group of 36 S&P 500 non-financial companies was distinguished by consistent, superior leaders over the 20-year span, outperforming the remaining S&P 500 firms in seven measurable metrics: return on assets, equity and investment, revenue and earnings growth, earnings per share (EPS) growth and stock-price appreciation.

We believe this study demonstrates the ability of “home-grown leadership” to consistently generate superior results and the importance of the board’s focus on effective CEO succession.

It’s clear that “Say on Pay” is not going away.  For companies whose shareholders rejected or expressed concern about the executive compensation programs with large numbers of negative votes, now is the time for boards to create a strategy to engage with shareholders to better understand their concerns.

Compensation consultant Robin Farracone of Farient Advisors warns boards not to “just sit there and do nothing” because it invites opposition to grow. Let it fester, she says, and it places the board and the company in a negative spotlight that “creates reputational damage and could even have a depressive effect on the stock price.”  

Boards have been reluctant to engage with shareholders because they often don’t have a picture of what a board engaging with shareholders might look like.  Often, they believe it is the job of the investor relations department. But “say on pay” focuses on the board’s role in approving compensation programs for the named officers for the company.  And shareholders expect the board to be responsive. 

“Good engagement takes different forms, but it’s critical to get an early start,” says Patrick McGurn of ISS, also interviewed in the Corporate Secretary article.  The Dodd-Frank requirement for Say on Pay voting was designed to encourage dialogue between the board and shareholders.  Some boards, like Prudential, established a dedicated compensation committee email address and actively seeks electronic queries on pay matters and anything else related to board work.  Prudential regularly sends board members and representatives on engagement exercises with investors.

Not only should board members be able to demonstrate that the compensation program is aligned with performance, but they should be able to explain compensation in general terms.  This has proven to be a difficult task that directors should correct by requiring themselves to explain

The US Chamber and others cheered the decision of the US Court of Appeals in overturning “proxy access,” which would have given large shareholders the right to nominate their own slate of directors. However,  it would be wise for sitting directors to think beyond the safety of their own board terms.

In rushing to get the rule in place, the SEC failed to “determine the likely economic consequences” of the rule and its effect on “efficiency, competition and capital formation” — all of which it must do by law.

But directors should consider the level of shareholder concern about their governance record–and not just the unions that are seeking increased benefits. Creeping federal regulation is the result of “corporate officers and directors are not doing their jobs,” according to Hillary Sale in her paper, The New ‘Public’ Corporation. “They have failed to understand the force of public scrutiny and have, thereby, failed their corporations.  They are not good public company stewards.”

The message to companies about the past ten years of increasing shareholder power is that shareholders are part of the governance conversation. Whether the SEC redoes its analysis and reissues its rule, corporate directors would do well to consider the level of shareholder disappointment that helped create Dodd-Frank and develop more effective board-shareholder engagement to satisfy and encourage long-term investment and participation.

The Spencer Stuart study, “Evolution or Revolution? Changes in Britain’s boards of directors from 1960 to 2010” is an important contribution to the field of corporate governance. In crediting author Sir Geoffrey Owen for his role in telling the story, Mark Stroyan, Managing Director of Spencer Stuart characterizes the history as both fascinating and important.  As it illuminates the past, the study sets the stage for the discussion of how boards will continue to adapt in the future.

 The search firm identified five concerns that boards need to address: 1) Preparing the next generation of chairmen with the caveat that not all CEOs are automatically suited to becoming chairmen, noting the critical skill of running a board meeting, drawing out and listening to all points of view, synthesizing the arguments and reaching conclusions without appearing to dominate. 2) The right of non-executives to seek advice because creating supplementary information channels is important for non-executive chairmen to discharge their duties in leading the board in oversight. 3) The pressure to appoint more women to boards has resulted in quotas in Norway.  And while many protest that there aren’t enough women with the relevant experience to serve, their view is that “there is a pool of potential candidates if boards are prepared to look less at proven general management experience and more at talent potential—to consider creative ideas and take some calculated risks.

While many sitting CEOs find it too time-consuming to sit on additional boards, Owen posits that 4) it is in the long-term interest of business that more working CEOs serve on boards. The 5^th challenge is to create more engaged boards but they note that when there are individuals in the boardroom who are really not contributing, it is “always uncomfortable to change the status quo” and ask the poor performing directors to leave.

One of the more interesting sidebars is “The Decline of the Guinea Pig,” which described the job of an independent director as a “delightful perk for important (and often self-important) business folk at the end of their professional career.”  These independents were “sometimes known as ‘guinea pigs’—for a guinea and a free lunch they were happy to sleep through any chief executive’s presentation of his corporate plan.”

In a webinar that provided significant information about the increasing responsibilities for audit committee members, KPMG’s Audit Committee Institute (ACI) and the National Association of Corporate Directors featured Carol B. Tomé in a webinar on June 23. Not only is Tomé Home Depot’s chief financial officer (CFO) but she also serves as  chairman of the audit committee in her board role at UPS. James P. Liddy, Vice Chair of Audit, KPMG moderated the webcast, which provided updates on key financial reporting/accounting developments, including FASB projects and “hot button” issues.  Asked what advice Tomé would give to CFOs she said, “Remember, it’s not a parade ground presentation—don’t spend excessive time on your slides.” It’s the engaged dialogue between the CFO and the audit committee that will really pay dividends. “Begin by thinking of the outcome you want and measure yourself against it.”  .  As for what audit committee members need to do to make the most of their interaction with the CFO, Tomé emphasized the need for interaction prior to the meeting.  Having a relationship with the CFO beyond just the board and audit committee meeting is critical. “It’s important to have that up front communication prior to the meeting,” she said.  Such conversations enable the CFO and audit committee to know what the issues are and where you should spend your time together. “Yes we have different roles but we’re all working for the shareholders.”

Attorneys Mike Melbinger and Erik Lundgren of Winston & Strawn offered a recap of the 2011 proxy season in a webinar this week.  Melbinger produces the most-read blog on compensation issues.  While only 35 companies received failed say on pay (SOP) advisory votes to date, Melbinger insisted that this proxy season was no walk in the park.  Not only do shareholders have heightened disclosure expectations, but seven more provisions of Dodd Frank will be in effect next year and he predicts that ISS and shareholder groups will be more dogged in their pursuits going forward.  He also noted that companies made extra efforts to achieve positive votes in 2011—more companies provided executive summaries in the CD&A and linked pay for performance. Many emphasized “get out the shareholder vote” including shareholder and ISS outreach.  

Tell your story was the theme of the action items that Melbinger suggested.  “Silence is not golden. Unless you affirmatively, unequivocally adopt best practices, unambiguously disclose them and beat ISS over the head with them, you run the risk that ISS and others will assume that you do not follow that best practice.”

Now is the time for boards to review what they learned from shareholders – whether at the annual meeting or proxy voting or shareholder outreach.  As for compensation,  and get rid of the problems and follow best practices now.

Former Defense Secretary Donald Rumsfeld told a capacity home-town crowd at the Four Seasons that every organization needs to continue to transform.  In his appearance for the Chicago Council of Global Affairs, Rumsfeld discussed the complex situation in Pakistan, his book “Known and Unknown” and the way a number of American and international institutions don’t fit our current information age and need transformation.

Rumsfeld calculated that he has lived through a third of our nation’s history.  As both the youngest and oldest Secretary of Defense, a White House Chief of Staff, Representative to NATO and four-term congressman from Illinois, he has been an active participant in that history. He took four years to write the book and digitized a portion of his archive and made it available on his website www.rumsfeld.com  in conjunction with the book’s publication.  Since launching in February, the site has received over 18 ½ million hits. Access to such a rich trove of information shows that “decisions are made with imperfect information.”   The bestseller has been called the first memoir of the information age.

Many U.S. and international institutions date back to the Truman years, an inflection point at the end of WWII and the beginning of the Cold War.  NATO, the UN, DoD, CIA and so many other organizations date back to those days.  “We’ve been changing and the world has been changing. And we need to be comfortable that the rest of the world is not like us.” 

Rumsfeld’s message was that all organizations need to continue to transform.  He’s led by example, making handwritten and typewritten memos and papers from his long government service available for everyone to draw their own conclusions.

AFLAC Chairman and CEO Daniel Amos has long endorsed transparency. AFLAC was one of the pioneers in offering a non-binding Say on Pay (SOP) vote voluntarily in the spring of 2008, prior to the financial crisis and Dodd-Frank.

In his recent comments at a financial industry conference in New York he conveyed what his company has learned in practice. “What did we do wrong,” was their initial reaction when AFLAC investors asked for the SOP prior to the new regulations.  Directors and management “came to the shared belief that investors should have the right to know how the compensation packages at a company are calculated.”

In his view, lack of transparency has an impact on stock price because it creates uncertainty for investors. Companies should view Say on Pay votes as part of an ongoing effort to be more transparent with investors. AFLAC’s conclusion is that open communication with investors and analysts is better for long-term growth.