It’s a well known that investors love steady returns and hate surprises. With more media scrutiny of Wall Street than ever and news reaching investors at the speed of light, shareholders are quick to examine what’s going right and wrong with their investments. Furthermore, they expect accountability from those companies they have invested in.
This increased scrutiny has included a focus on the once-clubby corporate board room, after several high-profile corporate bankruptcies and other troubles brought intense public and government examination of how business operates in the United States. And, as a result, a large number of corporations have moved to demystify their policies and bring in more outsiders to their leadership.
Today, many investors believe that better corporate governance translates into better investment returns and shareholder value. They believe a strong corporate governance program can lessen risk and enhance results. “Proxy proposals [are] another avenue to create shareholder value,” says Peter Vanderlee, portfolio manager with investment firm ClearBridge Advisors of New York, an affiliate of Baltimore-based Legg Mason.
And corporations are on the same page as well. Many publish the full details of their corporate governance programs. Plus, the market has seen the rise of services such as those provided by RiskMetrics Group of New York, which specializes in independent analyses of corporate governance practices.
What makes up a good corporate governance program? Good communication, strong disclosure practices and constructive engagement with investors, explains Patrick McGurn, special counsel with RiskMetrics Group.
Where there’s transparency, investors are more comfortable and confident about their holdings, and often companies and senior management are able to weather rough times more easily than when firms and their corporate governance practices are opaque, experts say. Where there’s opacity, troubles can be exacerbated, McGurn notes. “The way out of darkness with all companies has been to bolster corporate governance practices,” he says.
In the early part of the decade, investors and corporate leaders awoke to the hazards of weak oversight by boards. As Enron, WorldCom and others stumbled, investors saw billions of dollars of value vanish. Investors, impressed by the stellar returns of these firms realized a need to more closely examine how corporations were being run and earnings were being achieved.
Those high-profile collapses led to what RiskMetrics’ McGurn called a “once in a generation … wave of reform in corporate governance.” And corporate governance reform has now become widespread.
Take, for instance, the way corporate boards are created. Years ago, some corporate boards were largely hand-picked by CEOs. Today, independent nominating committees are becoming the norm. This is just one of many changes in corporate governance that have materialized recently.
A Say on Pay The hot topic for 2008 is “say-on-pay voting.” With say-on-pay, investors get a chance to voice their opinions about corporate compensation plans. For the most part, say-on-pay votes are non-binding. Still, shareholders want these measures.
If shareholders were to give a thumbs-down on a compensation package, “Nothing would have to happen, because it is non-binding” explains Vanderlee of ClearBridge Advisors. However, it might be disadvantageous for a board to ignore dissatisfied investors. “I would submit that if the majority of shareholders are voicing displeasure, it is an issue the company should address.”
Insurance firm AFLAC, for example, has voluntarily decided to submit to say-on-pay votes. Plus, a majority of telecom giant Verizon’s shareholders voted to have the firm start allowing say-on-pay votes starting in 2009.
Indeed, executive compensation has become a major corporate governance issue, but not because shareholders are necessarily upset with the level of compensation now given to executives. Rather, some investors are troubled by large payouts when a firm is doing poorly, say corporate observers. Investors want to make sure that both pain and gain is shared among a company’s different stakeholders, and some investors groups have actively embarked on a quest to further align executive compensation with shareholder’s interests.
Sorting out executive pay is a thicket that isn’t necessarily easy to clear. Compensation programs are often set up to meet tax and accounting needs, rather than to fit in with corporate strategies. Still, the Securities and Exchange Commission is starting to take a hard look at executive compensation.
Some compensation programs tie executive bonus payments to a firm’s performance within its peer group, and these plans may stipulate that the bonus is only paid if and when the firm outperforms its group. If there’s no out-performance then the bonus isn’t paid.