Tuesday, November 25, 2008

Democracy in the selection of Board of Directors

By R Raymond May
1526 Reverdy Oaks drive, Matthews NC 28105 (tel) 704.847.0008

I was asked at a neighborhood get together in November 2008 for my opinion on what was the root cause of this fine mess we find ourselves in at the end of 2008. Interesting, everyone knows it was all caused by the collapse in house prices and the sub-prime mortgages debacle! or was it?

No I said, those were only the first symptoms; the root cause was the wholesale institutional culture of corporate theft that has taken hold. The most clear cut sign is the incredible levels of CEO pay, golden parachutes and most of all pay levels on Wall Street. 17 billion dollars for the 2007 Goldman Sachs bonus pool! Almost equal to the company’s current market capitalization.

One group of the stakeholder club – “management” holds all the cards. The others - Capital, employees, community take what management gives them. There are lots of “good” managements but there are no checks and balances and it is hard to see the good from the “bad” until it is too late.

The only check and balance on management is the Board of Directors. But how is the board put into place and who checks the board? Certainly not the shareholders, but no, it is the same shameless management.

In response to the corporate scandals in 2001-2002, the major U.S. exchanges came up with new director and committee independence requirements, which are intended to enhance board oversight. We use this regulation event to shed light on the effect of board structure on CEO compensation. We find a significant decrease in CEO compensation upon compliance with these requirements. The significant decrease in compensation is due to a decrease in the option-based portion of the compensation. The results suggest that board structure is a significant determinant of the size and structure of CEO compensation.1
None of these changes has addressed the key issue – how do we select and remove a board of directors? Other than having a yes vote to management’s selections for us.

Corporations are so big, and the amount of cash available is just too temping. I remember thinking out loud as a young trader on Wall Street "why are we paid so much?" My boss the future CFO of JP Morgan replied "it is because we are so close to all the money".

During my time on Wall Street I observed two types of people. Type 1 had the corporation, group or businesses interests in mind foremost. Type 2 only had their own interests at heart. Types 2 were definitely the majority and you hoped you did not have to work for one of them. The business seemed cyclical in terms of which type was dominant.

Clearly this mess was caused by the gradual prominence of type 2s. What is the purpose of owning stock in a company where all returns go to management? Why own a company where the number of shares increases at the same speed as profits just to be given to management?

As the US government agrees to bailout Citibank all the talk on the TV shows is on the removal of the Board! but even if we wanted to how would that happen? And how would a new board be selected?

We need real democracy in the selection of Board of Directors!

1. Chhaochharia, Vidhi and Grinstein, Yaniv,CEO Compensation and Board Structure(October 2006). Available at SSRN: http://ssrn.com/abstract=901642

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