Tuesday, April 14, 2009

Checks and Balances

I learned in my grammar school civics class that our government was founded on a system of checks and balances that included some "creative tension" among the executive, legislative and judicial branches of government. By analogy, our capital markets depend on creative tensions among public company boards and management, institutional investors, external auditors, analysts, and the SEC. We continue to have a systemic failure and lock-up of all these checks and balances as the credit debacle continues to languish on.

Registered investment management firms are required to file form N-PX that lists how the asset management firm voted on proxy proposals solicited by their portfolio companies. It's a curious thing, but I rarely recall seeing a negative vote cast about director candidates, board governance changes, or management compensation plans. So, with the current clamor for "Say on Pay," it's good to remember that shareholders have always had a right to vote their opinion, but never did so during the periods of most egregious abuse. John Bogle of Vanguard has recently spoken out about the failure of his own mutual fund industry to act as effective fiduciaries for their retail and institutional shareholders. His address at Columbia University is worthwhile reading.

On the executive compensation side, as far as I can tell, the compensation consultants still have their place at the board table, inflating and escalating outlandish CEO compensation that has no relation to the creation of sustainable value. Board turnover does not seem to be out of the ordinary. Against the background of this systemic failure of checks and balances, it is not surprising that politicians step into the vacuum with rules that will not be efficient and will have unintended consequences.

So, the solution is for the market participants to 'fess up and join with the Federal government to devise a capital markets regulatory structure that provides efficient markets along with transparency, bounded risk-creation, and appropriate levels of protection for investors. Let's hope we start moving there soon.

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