Risk Management Breakdown at AXA Rosenberg: The Curious Case of a Quant Manager Trusted Too Much (PDF)
Authors: Professor David F. Larcker, Stanford Graduate School of Business, and Brian Tayan, Researcher, Center for Leadership Development and Research, Stanford GSB.
Published: May 30,2013

All companies face challenges designing a governance system that works best for their particular situation and structure.  Even the owners of privately held companies sometimes struggle with issues of separation and control.  The challenges can be particularly acute when a company founder has considerable influence over the organization and its culture, and third-party investors have been brought in to share ownership.

We examine the interesting case of AXA Rosenberg, a joint venture investment management firm founded and run by legendary finance professor Barr Rosenberg.  Although successful for a time, the firm almost collapsed due to a failure in risk management.

We examine the governance structure, unique personalities, and series of events that led to the breakdown of the firm and the SEC investigation that resulted in Barr Rosenberg’s lifetime ban from the securities industry.

We ask:

• Is it possible for a board to monitor a renowned executive with extremely specialized knowledge?
• How can the board satisfy itself that risks are appropriately known and monitored?
• How does an executive’s personality affect a company’s risk management practices?

New CEO and Board Research from Stanford and The Miles Group

2013 CEO Performance Evaluation Survey Results: 

In Grading CEO Performance, Financials Still Dominate (PDF)

Boards rate CEOs high in decision-making, low in talent development

 STANFORD, CA – May 22, 2013 – A new study conducted by the Center for Leadership Development and Research at Stanford Graduate School of Business, Stanford University’s Rock Center for Corporate Governance, and The Miles Group reveals that boardrooms are giving poor grades to CEOs for their mentoring skills and board engagement – but still prioritize financial performance above all else. More than 160 CEOs and directors of North American public and private companies were polled in the 2013 Survey on CEO Performance Evaluations, which studied how CEOs themselves and directors rate both chief executive performance as well as the performance evaluation process.

 When directors were asked to rank the top weaknesses of their CEO, “mentoring skills” and “board engagement” tied for the #1 spot. “This signals that directors are clearly concerned about their CEO’s ability to mentor top talent,” says Stephen Miles, founder and chief executive of The Miles Group. “Focusing on drivers such as developing the next generation of leadership is essential to planning beyond the next quarter and avoiding the short-term thinking that inhibits growth.”

 However, when actually evaluating the performance of a CEO, companies place very little weight on many nonfinancial performance measures. The survey found that only a 5% weighting was given to a CEO’s performance in the areas of talent development and succession planning, and only a 2.5% weighting was given to employee satisfaction/turnover. 

“While boards clearly see mentoring and talent development as weaknesses in their CEO, the problem is that they are not evaluating CEOs against those measures in a meaningful way,” says David F. Larcker, James Irvin Miller Professor of Accounting and co-director of the Center for Leadership Development and Research at the Stanford Graduate School of Business. “Financial performance still dominates the grading metrics, so if boards really want CEOs to focus on other things as well, they will have to change the way they evaluate those in the top seat.”

 Additional key findings of the 2013 Survey on CEO Performance Evaluations include:

• Directors rate CEOs high in “decision making” but low in people management areas. In addition to mentoring and developing talent, “listening” and “conflict management” were the skills least mentioned as strengths of the CEO. “The fact that these were in the bottom three means that there is a real problem,” says Mr. Miles. “Each of these should be at least in the top five of a CEO’s strengths, because they are critical components to excelling in the CEO role. Decision-making, which directors overwhelmingly stated was their CEO’s greatest strength, is important, because you don’t want a CEO with ‘analysis paralysis.’ But ‘planning skills’ – which also made the top three in CEO strengths – are really what CEOs should be delegating, not focusing on themselves.”

• Little weight given to customer service, workplace safety, and innovation in CEO evaluations. While accounting, operating, and stock price metrics are assigned high value by boards, other factors generally hold little worth when boards rate their CEOs. “Seeming important things such as product service and quality, customer service, workplace safety, and even innovation are used in less than 5% of evaluations,” says Professor Larcker.

• CEOs and boards believe the evaluation process is balanced. Eighty-three percent (83%) of directors and 64% of CEOs believe that the CEO evaluation process is a balanced approach between financial performance and nonfinancial metrics, such as strategy development and employee and customer satisfaction. “Unfortunately, the truth of the matter is that the CEO evaluation process is not that balanced,” says Professor Larcker. “Amid growing calls for integrating reporting and corporate social responsibility, companies are still behind the times when it comes to developing reliable and valid measures of nonfinancial performance metrics.”

• CEOs failing to engage boards. “Board relationships and engagement” tied with “mentoring and development skills” as the #1 weakness in CEOs. “This serious disconnect between management and the boardroom has multiple negative ramifications,” says Mr. Miles. “Board engagement is absolutely vital to the function of the CEO – and to the health of a company. How can the board understand what’s going on in the company if the CEO is not engaging?”

• Directors lukewarm when comparing their CEOs against peer group.  Forty-one percent (41%) of directors believe that their CEO is in the top 20% of his or her peers, while 17% believe that their CEO is below the 60^th percentile. “For almost half of directors to say that their CEO is just ‘in the top 20 percent’ is not exactly a ringing endorsement,” says Mr. Miles. “The board hires the CEO – they should believe that they have the individual in that job who is absolutely the best, or can quickly become the best. The fact that nearly 20% of directors feel that their CEO ranks below the top 40% means that a lot of CEOs should be preparing their resumes.”

• Disconnect in how CEOs and directors regard the evaluation process. Sixty-three percent (63%) of CEOs versus 83% of directors believe that the CEO performance process is effective in their companies. “Nearly a third of CEOs don’t think that their evaluation is effective,” says Professor Larcker. “The success of an organization is dependent on open and honest dialogue between the CEO and the board. It is difficult to see how that can happen without a rigorous evaluation process.”

• 10% of companies say they have never evaluated their CEO.  “Given their fiduciary duties, it’s strange that any company would not evaluate its CEO,” says Professor Larcker. “The CEO performance evaluation should feed all sorts of board decisions, including goal setting, corporate performance measurement, compensation structure, and succession planning. Without an evaluation of the CEO, how can the board claim to be monitoring a corporation?”

•  CEOs highly likely to agree with the results of their performance evaluation.  Only 12% of CEOs believe that they are rated too high or too low overall, and almost half (49%) do not disagree with any area of their performance evaluation.  “Shareholders have to wonder at the objectivity of the evaluation process,” says Professor Larcker. “It’s hard to believe that boards are pushing CEOs on their evaluations if they pretty much agree with their evaluation.”

• Only two-thirds of CEOs believe that their own performance evaluation is a meaningful exercise. “Even though a high percentage of directors and CEOs think that the CEO evaluation process is meaningful, this number really should be 100%,” says Mr. Miles. “Every board has the power to meaningfully evaluate the CEO – whether doing it themselves, or bringing in someone to do it, or some combination thereof.”

• Directors unlenient on violations of ethics but more forgiving of CEOs with legal or regulatory violations that occur on their watch. “A significant minority of directors – 27 percent – say that unexpected litigation against the company would have no impact on their CEO’s performance evaluation,” says Professor Larcker, while approximately a quarter of directors (24%) say that unexpected regulatory problems would also have no impact. By contrast, all directors (100%) say that their CEO’s performance evaluation would be negatively impacted by ethical violations or a lack of transparency with the board.

Stanford University’s Rock Center for Corporate Governance and Mr. Miles have collaborated on several research studies of CEOs and board directors, including the 2011 Corporate Board of Directors Survey and the 2010 Survey on CEO Succession Planning.

 For more information, please contact D Katie Pandes of the Stanford Graduate School of Business at 650.724.9152 or pandes_katie@gsb.stanford.edu.

 About Corporate Governance at Stanford

The Center for Leadership Development and Research at Stanford Graduate School of Business seeks to advance the understanding and practice of corporate governance and executive leadership. Stanford University’s Rock Center for Corporate Governance is a joint initiative of Stanford Law School and Stanford Graduate School of Business.

 About The Miles Group

The Miles Group develops talent strategies for organizations, teams, and individuals – focusing on high-performance, world-class leadership. The firm was founded by Stephen Miles, a recognized expert in C-suite and board effectiveness; coach to top CEOs and COOs; and keynote speaker to organizations around the globe. Headquartered in New York, The Miles Group advises top global corporations through CEO succession, executive transitions, board assessment and training, and talent development. The firm’s coaching and advisory services enable leaders to raise the bar on their own performance, as well as create an environment for success throughout the organization. For more information, visit www.miles-group.com.

Does the Gender of Directors Matter?

Miriam Schwartz-Ziv 

Harvard University – Harvard Kennedy School (HKS); Northeastern University – Finance and Insurance Area; Harvard University – Edmond J. Safra Center for Ethics

March 3, 2013

Abstract: 
I examine relatively gender-balanced boards of business companies in which the Israeli government holds a substantial equity interest. I construct a novel database based on the detailed minutes of 402 board and committee meetings of eleven such companies. I find that boards that included critical masses of at least three directors of each gender, and particularly of three women, were approximately twice as likely to request further information and to take an initiative, compared to boards without such critical masses. The ROE and net-profit-margin of these companies is also significantly larger if they have at least three women directors.

Governance, Incentives, and Tax Avoidance (SSRN) 

Authors: Chris Armstrong, University of Pennsylvania – Accounting Department; Jennifer L. Blouin, University of Pennsylvania – Accounting Department; Alan D. Jagolinzer, University of Colorado – Leeds School of Business; David F. Larcker; Stanford University – Graduate School of Business
Paper Date: April 17, 2013
Rock Center for Corporate Governance at Stanford University Working Paper No. 136 

Abstract:      

This paper examines the link between corporate governance, managerial incentives, and tax avoidance. Similar to other investment opportunities, unresolved agency problems may cause managers to over- or under-invest in tax avoidance relative to the preferences of shareholders. Using quantile regression, we find that the impact of corporate governance on tax avoidance is most pronounced in the upper and lower tails of the tax avoidance distribution, but not at the mean or median of this distribution.

Specifically, we find a positive relation between the financial sophistication and independence of boards and tax avoidance in the upper tail of the tax avoidance distribution, but a negative relation in the lower tail of the tax avoidance distribution. However, we find no relation between corporate governance and tax avoidance and either the conditional mean or median of the tax avoidance distribution. These results suggest that corporate governance tends to decrease extremely high levels of tax avoidance and increase extremely low levels of tax avoidance, which may be symptomatic of over- and under-investment, respectively, by managers. Our results also suggest that inferences about these relations that are drawn from the conditional mean and median and unlikely to be representative across the entire tax avoidance distribution.

Linguistic Diversity and Stock Trading Volume (SSRN)

Authors:  Yen-Cheng Chang,  Shanghai Advanced Institute of Finance; China Academy of Financial Research (CAFR);  Harrison G. Hong, Princeton University – Department of Economics; National Bureau of Economic Research (NBER); Larissa Tiedens, Stanford Graduate School of Business;
Bin Zhao, Shanghai Advanced Institute of Finance; China Academy of Financial Research (CAFR)
Paper Date: March 14, 2013
Rock Center for Corporate Governance at Stanford University Working Paper No. 134

Abstract:      

We test the hypothesis that the linguistic diversity of a stock’s investor base leads to more trading. Trading might be due to beliefs differing across languages or investor exposure to multiple languages leading to more trading ideas. Using stock message boards from China, which has ten languages, we measure the linguistic diversity of a stock’s investor base using a Herfindahl index of messages posted from different languages. A firm’s diversity increases in the number of languages spoken in the province where it is headquartered. Using the latter as the instrument, trading volume in a stock rises with its linguistic diversity. We then attempt to discriminate among competing mechanisms. We also show using a sample of forty-one countries that countries with more linguistic diversity have greater stock market turnover.

Where Experts Get It Wrong: Independence vs. Leadership in Corporate Governance [PDF]
Authors: Professor David F. Larcker, Stanford Graduate School of Business, and Brian Tayan, Researcher, Center for Leadership Development and Research, Stanford GSB.
Date: March 14, 2013
Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance and Leadership No. CGRP- 32

Over the last few decades, researchers have taken a thorough and critical look at corporate governance from various perspectives.  For the most part, they have found that structural features of corporate governance have little or no relation to governance quality.

For example, there is no evidence that having an independent chairman benefits companies.  At the same time, there is evidence that CEOs with different personalities require different levels of oversight. 

We examine this issue in greater detail.  We ask:

• Why isn’t more attention paid to contextual considerations in corporate governance?
• Why don’t governance experts base their recommendations on research rather than subjective opinion?
• How can corporate stakeholders take into account the quality of a company’s leadership to design more effective governance systems?

Read the attached Closer Look and let us know what you think!

Keywords: corporate governance, CEO and executive leadership, CEO personality, CEO-Chairman duality

Topics, Issues and Controversies in Corporate Governance and Leadership: The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. Larcker and Tayan are co-authors of the book Corporate Governance Matters.

“And then a Miracle Happens!: How Do Proxy Advisory Firms Develop Their Voting Recommendations? (PDF)

Authors: David F. Larcker, Allan L.McCall and Brian Tayan, Stanford Graduate School of Business
Date: February 25, 2013
Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance and Leadership No. CGRP- 31

Abstract:

Proxy advisory firms are independent, for-profit consulting companies that provide voting recommendations to individual and institutional investors.  Research shows that these firms have significant influence on voting outcomes.  Given this influence, it is important that investors ensure that the policies of these firms are “accurate”—i.e., that they successfully and reliably differentiate between good and bad future outcomes.

In this Closer Look, we carefully examine the process by which proxy advisory firms formulate their voting policies.  In doing so, we identify serious issues that raise questions about the accuracy of their recommendations.

We ask:

• How exactly do proxy advisory firms determine that a policy is “correct”?
• Who participates in the policy development process with these firms?  How do we know that their opinions are representative of shareholder broadly?
• Why don’t proxy advisory firms disclose the research that supports each of their voting recommendations?

Does Going Public Affect Innovation? (SSRN)
Author: Professor Shai Bernstein, Stanford Graduate School of Business
Date: October 14, 2012

Abstract:      
This paper investigates the effects of going public on innovation. Using a data set consisting of innovative …firms that …filed for an initial public offering (IPO), I compare the long-run innovation of …firms that completed their filing and went public with that of …firms that withdrew their filing and remained private. I use NASDAQ ‡fluctuations during the book-building period as a source of exogenous variation that affects IPO completion but is unlikely to affect long-run innovation. Using this instrumental variables approach reveals a complex trade-off between public and private ownership. The quality of internal innovation of public firms declines by 50 percent relative to …firms that remained private, measured by standard patent-based metrics. Public firms experience both an exodus of skilled inventors and a decline in productivity among remaining inventors. However, access to public equity markets allows firms to partially offset the decline in internally generated innovation by attracting new human capital and purchasing externally generated innovations through mergers and acquisitions.