Gretchen Morgenson on corporate governance

Gretchen Morgenson is finally finished with Pfizer, it seems. This week she’s aimed her laser pointer at Career Education Corporation, whose shareholders will meet May 18. Once again, she's telling us the poor shareholders need more voice.

The company has had “legal and regulatory problems” lately which have cut its stock price in half. But last month analysts started recommending the stock, saying that the company was making progress cleaning up its act.  But first quarter results released Wednesday were disappointing, and the stock fell again. So a shareholder, Steve Bostic, has been agitating for change. He's gotten shareholder approval of proposals to eliminate the staggered board and poison pill and to allow the shareholders to call a special meeting, and gotten the shareholders to express dissatisfaction with three directors now up for election.

But the company has terminated the poison pill, appointed new independent directors, instituted stock ownership guidelines for senior managers, and provided that directors must receive a majority of shareholder votes to be reelected. So what’s the problem? The shareholders got mad, the company responded.

Well, the company doesn’t want more interference from Bostic, and has said so in newspaper ads. It doesn’t want the directors Bostic is proposing, or a rule allowing a third of the shareholders to call a special shareholders meeting. It says the latter would be “very disruptive,” though it supports a two-thirds-vote rule.

As with Pfizer’s shareholders and all other shareholders of publicly held corporations, CEC shareholders are rationally apathetic. They hold diversified portfolios of shares or mutual funds and leave management to the managers. If the managers mess up, the shareholders or their funds sell, and resources are directed to other firms. These days private equity funds are ready to swoop in and make changes in an effort to make money on their investments. Shareholders simply lack the expertise and incentive to get routinely involved in management.

Morgenson doesn't like this system. First, she tells us Bostic is concerned that the company is spending shareholder money to oppose him. Morgenson indicates that the problem is that managers are more able to get reimbursement for proxy expenses than insurgents like Bostic. She notes that Richard C. Ferlauto, director of pension and investment policy at the American Federation of State, County and Municipal Employees, has backed proposals, so far unsuccessfully, to force companies to reimburse shareholders who contest director elections. But such a rule is sure to exponentially increase turmoil instigated by activists, including labor activists like AFSCME.

Second, Morgenson quotes corporate control adviser Gary Lutin as saying that "[n]egotiating concessions is not the same thing as respecting shareholder rights." So, by not responding to all of Bostic’s demands, but merely making partial “concessions,” the board is not “respecting shareholder rights.” In other words, if a an activist shareholder starts squawking, the board should step aside and let the shareholder call the shots. Lutin says that, "[w]hen a company's board doesn't respond to a clear message, whether it's a shareholder vote or evidence of misconduct, it means that every single member either supports or tolerates irresponsibility.” Wow.

Third, “several institutional shareholders” have voted for the directors Bostic opposes. Are they wrong? In writing about Pfizer, Morgenson was concerned that the institutions that were supporting management had a conflict because they were also getting fees managing Pfizer retirement funds. I was not impressed by this argument, but Morgenson’s not even making it here. She gives us no reason to believe that the institutions are acting irrationally.

So here’s what Morgenson is telling us. We should have more shareholder insurrections. The shareholders should revolt when the short-term share price goes down – that was the apparent trigger both at Pfizer and CEC. Shareholders should do what labor activists are telling them to do. They should look askance at institutional investors that sell instead of participating in the insurrection. As with the Pfizer election, Morgenson ominously ends her column with “[w]e shall see how they vote this year.” (In Pfizer, by the way, the insurgents lost.)

Shareholders and other readers should consider that Morgenson is using her pulpit at the NYT to push a highly questionable model of governance in which firms are continually riled by self-appointed activists while other institutional shareholders are shamed, or perhaps forced by new rules, to go along.  The main beneficiaries will be writers like Morgenson who will have thrilling stories to tell about incessant corporate wars (remember "yellow journalism"?), and labor activists who will have a weapon against managers that don't do their bidding.

Comments

[eric]

I agree that the result of this would be more drama, but isn't it funny that companies will say that their mission in life is to satisfy their shareholders, except when they don't want to?

[James Angresano]

In today's IHT (weekend edition, September 27-28) you wrote
Although America's housing collapse is often cited as having caused the crisis, the system was vulnerable because of intricate financial contracts known as credit derivatives, which insure debt holders against default.

You really need to get it right. To the extent that the system is collapsing it is due to the very high risk rating a high percentage of people who initially took out a mortgage and the lack of evaluating their riskiness. A house of cards was built that has later collpsed - partly with the help of misguided bankruptcy laws.

James Angresano
Professor of Political Economy