Ideoblog

The SEC on shareholder access

The SEC is re-revisiting this area. Here’s Jay Verret's summary, more from Professor B and Harvard’s Lucian Bebchuk, and my most recent comments on shareholder rights.

As my comments indicate, I am more interested in the fundamental issue of whether this should be left to state law than in the details of the proposal.  On this issue Bebchuk says:

Opponents also argue that establishing any minimum requirements for inclusion of director candidates on the company’s proxy card departs from the SEC’s traditional role into an area best left for state corporate law. However, the SEC’s proxy rules already mandate the inclusion of some information, including certain shareholder proposals, on the corporate ballot and accompanying proxy materials. The SEC’s proposal would merely expand the current mandatory requirements, and wouldn’t enter any new territory.

This is not much of a response to my argument that the federal role here should be shrinking rather than expanding.  Indeed, it further points up the harm in an incremental increase in federal power: this not only eats away the area left by state law but, as Bebchuk shows, feeds arguments for further expansion.

Moreover, as I've often said, including in my most recent post linked above, what about the "uncorporation"?  Federal governance rules are based on corporate norms. Will expansion of these rules create a demand for alternative governance forms. Or will they reduce the possibility of using these business forms for publicly held firms?  Here's a recent summary of how these devices could be used to solve the increasingly obvious problems of corporate governance. Maybe we should think twice before enshrining these mechanisms in federal law.

Some thoughts on the Shareholder Bill of Rights

Martin Lipton, with Jay Lorsch and Theodore Mirvis, opine in the WSJ about the havoc that could be wrought by Schumer’s proposed Shareholder Bill of Rights Act of 2009. That Act would require shareholder say on executive pay, direct shareholder nomination of directors, majority vote for directors, and no staggered boards.

Schumer's proposal provides an opportunity for everybody to work out their favorite theories. Lipton, et al, true to their usual managerial perspective, are concerned about the potential for governance that is overly focused on the “short-term.” They would go in the opposite direction, with directors’ elected to 5 year terms.

Steve Bainbridge doubts there’s a problem with executive compensation and, true to his director primacy approach, questions the proposed solution.

I'm no fan of say on pay. But if we really want to get serious about shareholder power, why cram a federal law down their throats.  Indeed, why not go the other direction, to say on SOX? 

Or, how about even more shareholder say, by letting the shareholders choose their corporation's state legal regime? As Professor B discusses, leaving corporate governance issues to state law allows for some experimentation, and attaches market prices to the various alternatives. See my and Erin O’Hara’s Corporations and the Market for Law and The Law Market, ch. 6.

Finally, why corporate law? Why not choice of form as well as choice of law? Even if shareholder democracy is not the answer, that doesn’t mean we should lock control in directors make managers or directors trustworthy stewards. Of course what I’m thinking about is the uncorporation. My theory is that managers can be disciplined by giving them stronger incentives and lightening their grip on the firm's cash. 

The answer, at any rate, is choice.  I'm not ready to let Sen. Schumer and his friends decide how all firms should be governed.

Rearranging the deck chairs at BOA

Ken Lewis was ousted as board chair at BOA. There’s no sign he’ll be replaced as CEO. The new chair is the 71-year-old president emeritus of Morehouse College in Atlanta who has no professional banking experience. "I don't know what Mr. Massey will do.” Charles Elson told the WSJ. According to the article, Massey was suggested in

conversations earlier this week among a small group of directors, including Mr. Lewis” because he “would present a "positive image" . . . and can devote plenty of time to the task because he is retired. . . . No other names were mentioned, and the directors voted unanimously in favor of Mr. Massey. By the time the vote totals and chairman change were announced, the directors were on their way home, said one person familiar with the events.

The new chairman will now deal with “a capital hole in the billions of dollars at the bank.”

Today I discussed my ideas about the uncorporation.

Rise of the Uncorporation: Tomorrow at Searle

Tomorrow I’m going to a Searle Center Research Roundtable on Jon Macey’s book, Corporate Governance: Promises Kept, Promises Broken and my forthcoming Rise of the Uncorporation. I’ve enjoyed past roundtables, but this is my first stint as target. It's a good group and should be interesting.

The book is nearing completion – watch for more on the book in coming weeks. At last, in one place, everything you wanted to know about the uncorporation, big and small, past, present and future.

Morgenson still silent on the NYT

As I have pointed out before (e.g.), the NYT’s Gretchen Morgenson, while loudly complaining about undemocratic corporate governance throughout corporate America (see my archive), hasn’t said anything “about the Stalinist corporate structure in her own backyard.”

And of course she’s railed even more loudly about executive pay. Nevertheless, as reported recently (HTBainbridge), her silence about her own employer continues even as the NYT pays its executives significant bonuses in the face of dismal financial results while asking employees to take pay cuts.

Surely Morgenson could provide special insight on this story. Could it be that the Times doesn’t want this story told about itself, even as it sold the story on others? Just asking.

Citigroup and AIG on Harvard Blog

My post on the Citigroup and AIG cases is up on the Harvard Corporate Governance blog. This expands on my earlier post on these significant cases.

The SEC: from fraud accessory to quack corporate governance

The SEC has been a miserable fraud watchdog – perhaps even Madoff's unwitting accessory. So what is it doing now?  Seeing how much it can mess up corporate governance. Per Dealbook, SEC Commissioner Elisse Walter has joined Chair Mary Schapiro in backing say on pay and shareholder access to board nomination.

I've described say on pay as "quack corporate governance." As I've said:

Efficient compensation must be crafted on an individual-by-individual and firm-specific basis to provide the right incentives and attract the best people. It's like designing a product. Can anybody seriously believe that shareholders en masse can make a meaningful, intelligent, up-or-down decision on executive compensation?

Here I note:

Unions already have secured an extensive executive compensation disclosure rule to whip up populist resentment about executive pay. The next step is to create a mechanism to bring that resentment to bear in corporate elections. * * * They are not seeking to represent the interests of investors generally. Their ideal is the sclerotic European firm, with its labor representatives on the board.

I added that say on pay also provides a basis for litigating board elections, increases benchmarking of compensation, increases firms' incentives to manipulate compensation, and spurs the drain of talent from publicly held firms.

Perhaps more importantly, as I discussed here and here (the latter summarizing my testimony before the SEC), these nuances of corporate governance -- executive compensation and director elections -- are best covered by state law.

These observations are more important than ever. We’re trying to get firms moving again, not hobble them. Politicizing corporate governance, distorting incentives, giving unions more leverage, etc, do not seem like ways to do this.

The SEC has not even been able to do its main job of policing obvious frauds. We should not expect it to do a better job mucking around in the sensitive arena of internal corporate governance.

Blankfein on what went wrong

Goldman’s Lloyd Blankfein, writing in FT, HT Dealbook says:

• risk management should not be entirely predicated on historical data. * * * Our industry must do more to enhance and improve scenario analysis and stress testing.
• too many financial institutions and investors simply outsourced their risk management [to rating agencies]
• many risk models incorrectly assumed that positions could be fully hedged. * * * we did not, as an industry, consider carefully enough the possibility that liquidity would dry up, making it difficult to apply effective hedges.* * *
• managers of companies with large off-balance sheet exposure did not appreciate the full magnitude of the economic risks they were exposed to
• The industry let the growth in new instruments outstrip the operational capacity to manage them. financial institutions did not account for asset values accurately enough.
• Risk and control functions need to be completely independent from the business units. And clarity as to whom risk and control managers report to is crucial to maintaining that independence.

So what’s his prescription?

self-regulation has its limits. We rationalised and justified the downward pricing of risk on the grounds that it was different. We did so because our self-interest in preserving and expanding our market share, as competitors, sometimes blinds us – especially when exuberance is at its peak. At the very least, fixing a system-wide problem, elevating standards or driving the industry to a collective response requires effective central regulation and the convening power of regulators.

But then he says:

We should resist a response, however, that is solely designed around protecting us from the 100-year storm. Taking risk completely out of the system will be at the cost of economic growth. Similarly, if we abandon, as opposed to regulate, market mechanisms created decades ago, such as securitisation and derivatives, we may end up constraining access to capital and the efficient hedging and distribution of risk, when we ultimately do come through this crisis.

So business went wrong. Now government has to fix it. But government can go wrong too through excessive or wrong regulation.  Government came up with SOX to improve firms' management of risk -- yet Blankfein shows how little that accomplished.

If you can’t trust business to get it right, why trust government? In fact, the opposite presumption would seem more logical.  The same profit motive that Blankfein says can go awry also operates powerfully to get firms on track. 

If business and government will make mistakes, what should we do?  Well, it's important to note that the governance mistakes Blankfein lists were made mainly by corporations whose managers simply followed the herd off the cliff, despite risks that were obvious in hindsight.

There is an alternative.

The stupid bailout pay caps

I’ve been lax in blogging about the bailout because there’s so much stupidity I haven't been sure where to begin. Well, now I have an idea where to begin – the President’s plan to curb pay for recipients of “exceptional assistance” to less than $500,000/year other than restricted stock, with an effective hurdle set at the payout of the debt.

The proposal will also include shareholders "say on pay" for senior executive compensation, which I’ve described as “quack corporate governance,” but which our President nevertheless sponsored in the Senate.

According to the WSJ:

the president intends for these standards to mark the start of a long-term effort to institute a "sensible framework" for executive compensation that promotes sound risk management and long-term growth while preventing future financial crises. Possible steps for the future include requiring compensation committees on all public financial institutions to review and disclose strategies for aligning compensation with sound risk-management.

Note that this proposal applies not just to the executives who messed up, but to new hires that might lift the firms out of their morass. It therefore not only doesn’t focus on the bad, but helps free them from competition in the executive talent market.

This is so blindingly stupid that it would barely deserve comment but for the fact that it threatens to help further impede a desperately needed recovery. Here's John Carney:

[W]e'll find ourselves in a strange world in which competition for talent is severely limited. * * * [T]his would have the effect of allowing dead in the water firms to continue on without fear of losing their best performers. This, in turn, might actually encourage Wall Street to further misbehave. * * *

The exit of talented people is typically a signal of financial distress on Wall Street. * * * Once you max out compensation at five hundred grand, you'll find that this signal becomes useless.

Overall, this could hurt our economic recovery by limiting the rewards for making smart bets on the companies and sectors that will lead us into economic health. * * * Basically, we'll wind up creating a zombie version of Wall Street that will have little incentive to rebuild our economy.

Carney's skeptical that it will work because financial pros will find "work-arounds" for the limits.  But that won't eliminate the costs because the work-arounds will not necessarily be incentive equivalents.

But I do have one good thing to say about the proposal: it could hasten the flight of talent out of the traditional corporate firms that created the mess. Private equity may not be thriving now, but this bodes well for these firms’ ability to attract the best talent in the future, despite the risk.

Update:  Here's some of the proposal.  Though it's limited in scope to a few executives and companies, these are the executives and companies for which incentive pay is most important.  Plus, this could be a model for the future.

Wall Street pay

Obama thinks Wall Street bonuses are "shameful," and Sen. McCaskill introduced a bill that would ensure that executives at bailout financial companies would get no more than the president (does that include free rent?). These moves are about as surprising as sunset in view of the meltdown and facts like this:

From 2002 to 2008, the five biggest Wall Street securities firms paid an estimated $190 billion in bonuses. Those companies churned out $76 billion in combined profits during the same period. Last year, the companies had a combined net loss of $25.3 billion, yet paid bonuses of roughly $26 billion.

The fact is that there is a problem. As Jon Macey was quoted as saying in the story that the above appeared in, "the foxes have been guarding the henhouse."

Yet we don't want the government to decide this stuff. After all, compensation laws determine who works where. As a WSJ editorial says today:

The danger of targeting what capitalists we have left for abuse or prosecution is that they will stay on strike, as they did in the 1930s. It won't be pretty this time either.

The last thing the financial markets need is Atlas Shrugged.

The problem, as Macey suggests, is governance – specifically corporate governance. I said that at the outset of the blowup, back in September, when Lehman, AIG and Merrill blew up on Black Sunday:

I think this is the wake up call for corporate governance. Despite all the regulators, independent directors and Gretchen Morgenson, big firms were taking catastrophic risks under the radar. And, yes, the culprits were the conventionally governed big corporations. * * *

And now it’s the similarly governed private equity firms that are waiting in the wings to pick up the wreckage. 

In other words, the Uncorporation. Uncorporations control not only risks, but pay. In the Uncorporation, pay can be very big, but it's designed to provide incentives. You don't keep getting bonuses in good years and bad. If the investors hurt, you hurt until the investors get well and you clear your hurdle.

Political manipulation of Wall Street or any other pay is just scapegoating that accomplishes nothing. In this case the pay is a symptom of a deeper governance problem that needs to be fixed.

The real danger is that Congress will regulate the cure, too -- private equity, hedge funds and the other uncorporate alternatives to corporate governance.