Thursday, April 30, 2009

A One Man Band?

I just happened to look at the Wall Street Journal online to see the inevitable announcement about Chrysler entering a bankruptcy process. The accompanying photo is a bit startling. Where you expect to see the Chrysler CEO spinning a chrysalis yarn, there is the President of the United States. In the background are a bunch of politicos, including the increasingly omnipresent Tim Geithner and Larry Summers.

Within twelve hours, President Obama assured the nation that he himself is assiduously and continuously monitoring the worldwide spread of the swine flu while now simultaneously solving the previously intractable problems of Chrysler. Perhaps he is receiving Tweets to his Blackberry. By the way, I haven't included many of the President's other personal projects, such as monitoring Pakistan, making progress in Iraq, and maintaining a vigilant eye on the poppy fields of Afghanistan. What happened to his Vice President? Better yet, what happened to his Cabinet? Secretary of State Clinton is off "dialoguing" somewhere, but her workload seems tame by comparison to that of the President.

It's good to have a confident self-belief. However, we know from the world of know-it-all, self-absorbed CEO's (pick a name, any name: Welch, Greenberg, Fuld, Cayne..) that there is a razor's edge between self-belief and hubris. It is always good for a real leader to delegate to trusted lieutenants who are expert in their areas. I forget, do we have a Car Czar?

Green Shoots in Governance

Shareholders at Bank of America were able to carry a vote to separate the roles of CEO and Chairman of the Board of Directors. This is a very encouraging sign. Although separating the roles is not sufficient to guarantee superior performance or governance, it allows the board and management to concentrate on their distinct roles, avoids conflicts of interest, and permits the exercise of comparative advantage between executives and directors.

The less encouraging news is that the Board Chair is a college president. Academic institutions are not known for transparency, effective cost management, providing value for their student customers, or for maximizing returns. However, it is possible that the new Chair is someone who can bring a fractious board together into an effective governing unit.

If CEO Lewis is in fact a good operating executive, he is now free to concentrate on what needs to be done on the business side, and he can leave all the other issues to the Board Chair. He should be thankful and he should be relieved. If he and his supporters take the move in the wrong way and look on it as a "vote of confidence," then he will lose his focus and probably needs to be monitored closely by the board.

Some measures for shareholder non-binding "say on pay" resolutions were defeated, but there are a few green shoots in this proxy season.

Tuesday, April 28, 2009

Say (What) On Pay?

Directors of Chesapeake Energy have managed to thumb their noses at investor dissatisfaction over outrageous executive pay packages by ponying up $112 million to its CEO, which included a bonus equal to more than 75 times the CEO's base pay and $33 million in stock awards. Please note that the stock price declined during the measurement period; imagine the bonus if the stock price had risen!

Just to make sure that investors got a finger in both eyes, the board also did business with some CEO-affiliated companies and bought the CEO's collection of maps and artwork for $12 million.

So for all the talk about proxy access and "say on pay," some boards manage to remain tone deaf to their fiduciary duties and to any kind of business common sense.

Monday, April 27, 2009

The Future for GM Shareholders

Today, the Federal Government announced the latest version of the GM bailout plan. A small note in this version has GM retaining the GMC division and shedding Pontiac, which is a much better idea than the original proposal that would have sent GMC into a "bad company," along with Saturn. So somewhere in the discussion, the Administration learned something about GM's light truck business and the value of the GMC nameplate and products.

The proposed exchange offer would have bondholders getting $0.38 on a dollar versus versus $0.10 that is reflected in the secondary markets for the bonds; however, according to the Wall Street Journal and Morgan Keegan, they would get only a 10% interest in GM after the restructuring.

What's more troubling is the fact that the Government will be a much larger equity holder than in earlier proposals. The role of independent trustee directors who represent the taxpayers has always been without precedence and legal guidance. Legitimate questions are raised about the objectives of these independent trustees. It seems reasonable that their minimal duties should be to ensure that the taxpayer injections of funds are repaid, and that they company is run to generate a commensurate return without taking undue risks. Now, however, comes the inevitable discussion from observers like Robert Reich that these directors should have other, broader social objectives.

Finally, I wouldn't be surprised to see proxy access proposals coming from minority shareholders like the UAW to achieve their own ends. Would the government's trustee directors owe loyalty to proposals from politically-motivated minority shareholders? I suspect there would be pressure on them to be beholden to special interests like these.

So, where would that leave an institutional shareholder? In the short-run, there may be a quick trade for hedge funds in the shares, if the economy is beginning to turn. However, this plan will have unintended consequences that are not visible yet to downstream players like the parts suppliers and the surviving dealer network.

I would guess that the most bullish analysts would rate GM shares a "Hold."

Thursday, April 23, 2009

What Does Pakistan Have to Do With BRICs?

Brazil, Russia, India and China are the so-called BRIC countries, deemed to be future global leaders because of their natural resource, technology, and human capital advantages over other emerging countries.

The news from Pakistan continues to be grim, and the news coverage is extremely poor, which is a byproduct of the breathless, callow and superficial coverage accorded to international affairs by well-coiffed cable news reporters in fatigues. It seems as if the central Government of the Pakistani state is either on radio silence or on the verge of collapse. Either scenario is very bad for world business and should be covered by business reporters rather than obsessing about a meaningless first quarter earnings report by a bank.

If the Pakistani state is collapsing, the immediate question is "Who's in charge?" The answer may not be consoling. Now with India embroiled in its own election process, it is unclear how some of the extremist viewpoints that are part and parcel of parties and coalitions will react to developments in Pakistan. If extremists view a state collapse as an opportunity to settle long-standing grudges, that will be very bad for human rights, civilians, and for business.

So, India will have its own issues going forward, in addition to the glacial pace of true economic and social reform in the country. So, we don't know if this BRIC belongs in the wall of fame yet.

Related developments in Afghanistan shouldn't be surprising either, as US commanders are now citing the deterioration in the southern Afghan Taliban strongholds. Great progress has been made with limited resources, but the insurgencies in Afghanistan and Pakistan are very closely related. Developments in both countries bear much more in-depth, thoughtful dialogue and foreign policy initiatives. In the long-run, that would be good politics and good business.

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.

Monday, April 6, 2009

It's Still A Bad Plan

In a post dated February 13th, we made two key points. First, we felt that forcing financial firms into some form of bankruptcy was superior to substantial direct investment by the government. Second, we believed that the plan-without-details for buying toxic assets through private-public partnerships was an extremely bad idea.

Now with the passage of time and some more details, we feel even more strongly about these positions. In a paper by Kenneth Ayotte and David A. Skeel, Jr., "Bankruptcy or Bailouts?", the authors note that it has been a guiding principle of Fed Chair Bernanke and former Secretary Paulson to "..avoid bankruptcy filings by the distressed firms...based on the belief that if a troubled firm files for bankruptcy, the consequences would be severe." The risks are categorized as firm-specific, including the rapid dissipation in value of the firm's assets, and systemic, such as the continued erosion in confidence. They note that three days after filing for Chapter 11 protection, Lehman Brothers had garnered court approval for the sale of its North American investment banking operation to Barclays, which provided $450 million debtor-in-possession financing. Two weeks after filing, Lehman had sold its European, Middle East and Asia operations to Nomura and its investment management business to two private equity firms. Through this example they show that the concerns about bankruptcy being slow and increasing firm specific risk, are not as significant as interventionists say they are. The authors are, respectively, law professors at Northwestern and the University of Pennsylvania.

Nobel Laureate Joe Stiglitz, writing in the New York Times ("Obama's Ersatz Capitalism," March 31, 2009) exposes the Geithner plan to purchase troubled assets via public-private partnerships. His characterization, drawn through two scenarios, shows that the plan socializes the potential losses, while offering private investors, pre-crisis returns of more than three times their equity investment. Professor Stiglitz sums it up best when he says, "The Geithner plans works only if and when the taxpayer loses big time." Yet, this plan cannot die at this point, for political reasons.

Today it is being tweaked again, not for its fundamental construction, but for issues of access by smaller firms to the candy being handed out by the Fed and Treasury. As several observers have noted, the ongoing financial crisis is not fundamentally about liquidity, but about confidence in the financial system. Despite all the press conferences and releases, very little of substance has been accomplished to restore confidence in the efficiency, transparency, fairness, and governance of the financial system.

Thursday, April 2, 2009

Sharing A Podium

About ten days ago, I was invited to a second year law school class on corporate governance at the University of St. Thomas, given by adjunct Professor John Stout. I shared a panel chair with Tom Holloran, who heads up the Center for Ethical Leadership in the Professions. I talked about the changing role of a public company CFO in relation to the board of directors. Tom--who incorporated Medtronic, was CEO of Dain Rauscher and CEO of Medtronic--talked about a wide range of issues that really got me filling up my notebook.

Tom described business as a "morally serious calling." In a law school associated with a Catholic university, the word "call" or "vocation" has a particular meaning. In his mind, business must provide an environment where employees can find personal satisfaction and a life of commitment to others. In my fifteen plus years as a Wall Street analyst, visiting hundreds of public and private companies, I can count on one hand the number of times I heard an executive speak to these kinds of ideas.

He said that if an enterprise were to describe itself solely in terms of a mission to maximize shareholder value, then Tom believed that the employees of that enterprise would find that "their calling lacked nourishment."

He then quoted Bartlett and Ghoshal, "A New Manifesto for Management," who said, "Purpose--not strategy--is the reason an organization exists." When I was the CFO at Possis Medical, we developed a new tag line under our logo that said, "Bringing Medical Possibilities to Life," and it was clear, easy to remember, and it summarized what we were all there for--our calling, so to speak.

I found a related article from Bartlett and Ghoshal in the MIT Sloan Review (vol. 43:2, 2002) and here is some material from the abstract:

"Forget capital; it's relatively easy to obtain nowadays. Today's scarce, sought-after strategic resource is expertise, which comes in the form of employees. Although organizations have changed mightily from the days of hierarchical, top-down management, they still have a long way to go."

Human resource professionals should have an important seat at the table in trying to maximize the return from human capital. In fact, HR is most often a record-keeping, compliance-oriented, lawsuit-preventing function that is the caboose on the executive management train.

Bartlett and Ghoshal talk about two tasks, a linking task and a bonding task. The describe the linking task as finding "a way to embed individual-based knowledge in the company, making it accessible and useful not to just one unit or one function, but to the entire organization."

In my website,, I use a term"embedded knowledge," which means everything that is known and has been deposited in an organization through the cumulative experiences of executives, managers, and line employees that have been part of the organization's life. This embedded knowledge can be tapped, but it is a process like spelunking or setting a new route on a mountain. It's iterative, has long pauses, retreats and straight shots upward. The authors are directing HR executives and managers to institutionalize a process for "linking" this individual-based knowledge. For you IT experts out there, a collaboration tool can help, but it's more than a piece of software. It is a mindset and a culture that has to be established first, and it rarely has, in my experience.

The second "bonding" function is described as creating an environment where people can express their individuality and align their efforts with a purpose. While Bartlett and Ghoshal assign this task to HR, it seems to me that this is something that has to come from the very top, if not the board of directors then from the CEO, with continuity beyond the tenure of one individual.

Of course, the rewards from hewing to a purpose and creating an environment where sustainable value is created must then be shared throughout the organization. This is also where the modern public corporation has fallen down with its continuing acquiescence to out sized compensation for CEO's regardless of performance.

Wednesday, April 1, 2009

Medtronic Business and Law Roundtable (Pt. II)

Continuing from a previous post covering Professor John Coffee's presentation, the next presenter was Lizanne Thomas,Chair of the Global Corporate Governance Team for Jones Day, the largest law firm in the world. Lizanne is an outside director for Krispy Kreme doughnuts. Krispy Kreme launched its IPO, I recall, at a price of about $10 per share, reached well above $45 per share, and settled down below $2. It is a classic case for how not to run a business, and how not to deal with public disclosure.

She talked about the business judgment rule, which requires directors to show loyalty and care in all their deliberations and decisions regarding the company for which the shareholders elect them as fiduciaries. Lizanne noted that some boards take this rule and force themselves into a process-oriented oversight, rather than digging into the substance of business decisions and the risks that they entail. No matter how smart regulators think they are, they cannot, in her opinion, "legislate trustworthiness into general corporate behavior."

She advised all corporate directors to "remember, relish, and assert their independent roles." Lizanne always advises her board clients to never succumb to management pressures and approve what they don't fully understand. This seems like a simple point, but the interpersonal dynamics governing this situation go unnoticed. If the board of a financial services company is listening to a long, PowerPoint presentation, full of charts, graphs, and mathematical model outputs covering risks in a derivative portfolio, I can assure you that most directors remain silent. The ones who have already bought into management's strategy are nodding their heads and going "Uh huh." It is very difficult for a peer who is a director to say something like, "Look, I've been a CEO of an S&P 500 company, but I confess that I don't intuitively understand this strategy and its risks. Can you make it simple for me?" Everyone drinks the Kool Aid; it's much more collegial and face-saving that way.

She thinks that a lot of board decisions that seem overtly foolish came about not from a motive of pure greed, but from a lack of understanding. Incidentally, that doesn't make it any less shameful or regrettable, but I thought that was an interesting comment from someone who is a leader in the legal practice of advising boards of large, public companies. No proposal should go forward through a board approval, she suggested, without every one agreeing on the three biggest risks to the project and deeming these risks acceptable.

On executive compensation, Lizanne Thomas said this had to be reformed and that pay should be for "sustainable performance." She cited the work of Frederic W. Cook in this regard.

She also noted that corporations are devoid of an internal moral code. Lizanne also chided her colleagues in the legal profession for punting when they need to confront a board or management that are paying them hefty fees by taking the pass, "Ultimately, it's a business decision."

William Chandler III is Chancellor of the Delaware Court of Chancery. Delaware is looked to as the bellwether for corporate matters, trust and estates,and other fiduciary matters. Their goal, the Chancellor said, was not to instill public trust in corporations or business, but rather to earn the trust of the public in the integrity of the Chancery Court's process.

In general, he said, corporations are expected to behave in a way that is equitable and fair. Delaware corporations are expected to obey the statutes, and this means that they should hold a duly called annual shareholder meeting, and they should approve all significant transactions after reviewing them with due care and with loyalty to both the corporation and to the interests of stakeholders.

Boards also exert fiduciary duties that should also be based on equitable principles. Chancellor Chandler used words like "duty," "obligation," "fidelity, "faithfulness," and "loyalty." For someone like myself, steeped in quantitative and financial rubrics, it was very interesting to hear these kinds of words being cited as being the bedrock supporting corporate governance.

The opinions of the Chancery Court were referred to as "moral stories," and I have to say that they make interesting reading just as do Warren Buffet's letters. The opinions are offered as road maps and a way forward for directors and officers of public companies.

Rakesh Khurana is Professor of Leadership Development at the Harvard Business School, and he gave a very long presentation that was time compressed; my summary doesn't do it justice. In 1950 he noted that business schools turned out about 3,000 MBA's per year, whereas today the industry produces about 120,000 per year. He cites the work Maureen Tkacik . Maureen's work is full of dark humor and the satirist's truth. Rakesh mentioned that MBA students today run their lives like "little corporations," and he rues their failure to view the modern corporate organization in a high minded or holistic way. This tied back in my mind to the spirit of William Chandler's remarks.

Whereas in 1955, there were 138 accredited institutions issuing the MBA degree, in 2000 there were 995 institutions,many of which are not accredited. Early theories of the firm, which I learned about in Milton Friedman's book on price theory, talked about the firm's objective function being to maximize profit. Michael Jensen of the Harvard Business School eventually changed that into the notion of maximizing shareholder value in a seminal 1997 paper.

Now, a confluence of events conspired to set the stage for decades of debacles. The large stock of MBA's fanned out into the S & P 500, where about two-thirds of the CEO's have MBA's, with Harvard holding the number one ranking among this group. Warrent Buffet describes the transformation as one from "owner capitalism" to "managerial capitalism." The MBA mindset taught these executives that they were nothing but agents of the shareholders. Their self-styled technical and quantitative expertise put them beyond their boards and led them to drive strategy, tactics, and financial management towards short-term earnings goals and quick hits in their share prices. These managers also put into place outsized variable compensation schemes that guaranteed huge rewards for themselves with no regard for sustainability and long-term value creation.

As institutional ownership became the dominant model for large, public companies, "earnings visibility" became a code word for "just deliver the quarter and talk up your stock's P/E." This exclusive focus on shareholder value was enshrined in a 1997 Business Roundtable proclamation. Today, we have the Aspen Principles--quite a difference.

He also noted the irony that directors, faced with technical doublespeak from both management and institutions, chose to outsource a lot of their basic oversight functions to corporate governance consultants, investment bankers, valuation consultants, and executive comp consultants. Directors, he said, fell prey to a "culture of politeness and power asymmetries."

Professor Lyman Johnson in his concluding remarks emphasized that there is no law that says directors are to maximize shareholder value as a primary or exclusive governing principle. Chancellor Chandler noted that regulatory law had completely failed in the current crisis. Professor Coffee noted that securitizations started becoming more toxic when the issuers were no longer required to retain the lowest tranches on their books.

Again, I hope that this summary stimulates thoughts and questions for the readers of this blog.