Archive for the ‘Strategy & Risk’ Category

Union Activism: Do Union Pension Funds Act Solely in the Interest of Beneficiaries? [PDF]

–Response from Brandon Rees, Acting Director, AFL-CIO Office of Investment

Authors: Professor David F. Larcker, Stanford Graduate School of Business, and Brian Tayan, Researcher, Center for Leadership Development and Research, Stanford GSB.
Published: December 11, 2012

Union pension funds manage approximately $3.5 trillion in retirement assets on behalf of public and private sector employees covered by collective bargaining agreement.  They are also very active in the proxy process, sponsoring approximately one-third of the shareholder proposals that are included in corporate proxies each year.

Federal and state laws (including ERISA) require that the trustees and administrative bodies that oversee these funds manage their plans “solely in the interest of participants and beneficiaries.”  Furthermore, the U.S. Department of Labor is clear that pension funds are not to use plan assets and their voting rights “to further legislative, regulatory or public policy issues through the proxy process.”

We examine this issue is greater detail, including the types of proposals put forward but union pension funds, the support these proposals receive, and the companies they target.  We ask:

• Are union-sponsored proposals made solely in the interest of their pension beneficiaries?
• How can the public or a pension beneficiary assess the motives of funds that sponsor proxy proposals?
• How do union pension funds determine which positions to advocate and which companies to target?
• Are unions violating their ERISA duties by sponsoring these proposals?

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

Banking Directors Need to be at the Top of Their Game

November 10, 2012
Dr. Richard Leblanc
BoardExpert.com

There’s an old maxim that corporations don’t fail, boards do. And when banks fail, the reason is poor management, which is the fault of a poor board.

Take the case of Lehman Brothers, the financial services firm that collapsed in 2008 and played a big role in the global economic downturn. Stanford University professors David F. Larcker and Brian Tayan noted that Lehman’s board was lacking financial services experience and current business acumen. In fact, the former CEOs on the board were, on average, 12 years into their retirement. “This raises the question of whether the professional experiences of Lehman board members were relevant for understanding the increasing complexity of financial markets,” wrote Larcker and Tayan.

Well, the job of a bank board isn’t getting any easier. Following the financial downturn, banks have been placed under greater scrutiny and new regulations, both in Canada and abroad.

That’s why, more than ever, banking board directors need to be at the top of their game.

Last week, I spoke to bank directors in Dallas, Texas, about banking governance best practices as a result of a review that I had conducted for the Office of the Superintendent of Financial Institutions. (The OFSI is Canada’s banking regulator.) Specifically, I looked at Canada’s governance guidelines and board assessment criteria and compared them with international financial regulatory practices and recent developments. I provided the OFSI with suggestions for revisions.

Some proposed board reforms to Canada’s deposit-taking institutions and insurance companies sectors under the new guidelines include:

-Having directors who possess risk management and relevant industry experience;

-A risk committee that oversees enterprise risks, and a chief risk officer who reports directly to this committee and the board;

-Board approval of the internal control framework to mitigate all material risks to the financial institution, and board monitoring of internal control effectiveness;

-Expert third party reviews of the board’s effectiveness, risk management effectiveness, and effectiveness of oversight functions (such as internal audit), with results reported to the board;

-Enhanced director orientation and training, self assessment and external reviews;

-A board-approved risk management statement that translates into cascading limits and thresholds for all material business risks (e.g., credit limits, loan losses, capital levels);

-The internal audit function should report directly to the audit committee; and

-The audit committee, not management, should approve the scope of the external auditor’s engagement and fees.

When I asked for a show of hands as to how many banking directors adopted at least some of the above best practices, about half the hands went up.

However, it’s apparent that many boards aren’t prepared for a new era of banking regulations.

Remember the JPMorgan board of directors that oversaw the derivative failure that cost the bank several billion dollars? Well, here is the current board. Last I checked, not a single director other than the CEO had banking experience. This is wrong.

In 2009 and 2010, there were a total of 297 bank failures in the U.S., according to the Federal Deposit and Insurance Corporation. In the second quarter of this year, the FDIC identified 732 “problem” banks which are at risk of failing.

At the event in Dallas, one of the speakers brought up a good point. “Don’t get involved in something you don’t understand,” said Charles G. Cooper, commissioner of the Texas Department of Banking. He added: “The duties haven’t changed, but the topic is harder.”

And he’s right. That’s why it’s vital that banking boards are well-equipped with qualified directors for this increasingly complex environment.

Interview with Darrell Duffie
Douglas Clement - Editor, The Region Published June 15, 2012

In the increasingly vital yet bewildering world of financial economics, Darrell Duffie is both a deep-level theorist and a hands-on plumber. He marries abstruse theory with solid reality and, unlike most economists, can then lucidly explain this often awkward union to those without his intuitive grasp. Few are better suited, then, to evaluate and clarify key challenges in the aftermath of the recent financial crisis. Duffie can’t eliminate the fog, of course, but his insights are among the sharpest.  Read more here.

Link to Prof Duffie’s bio and research.  

•  Leadership Challenges at Hewlett-Packard: Through the Looking Glass  (PDF)
  By Professor David F. Larcker and researcher Brian Tayan, MBA 2003, Stanford Graduate School of Business, Corporate Governance Research Program

The board of directors has a long list of responsibilities in all areas of governance.  However, to many, the fundamental obligations of the board are simple and distill down to two: 1) evaluate and approve the corporate strategy and 2) hire and fire the CEO. The Hewlett-Packard Company has had four leadership changes over the last twelve years.  It has also faced numerous strategic changes, as well as controversies and challenges at the senior management and board levels.

We examine these issues and ask:

* Does the board of directors understand the skills and experiences needed to run the company?

* Have they settled on a corporate strategy?

* Why has the board repeatedly appointed an external, rather than internal, executive as CEO?

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

To receive monthly alerts about the Closer Look series, please email the Stanford Corporate Governance Research Program at corpgovernance@gsb.stanford.edu. You can also follow more corporate governance news on Twitter: @StanfordCorpGov .

To view the entire collection of  Stanford Closer Looks please click here.

Contacts

• Market for Corporate Control  (Powerpoint Presentation) 
  Authored by Professor David F.  Larcker and BrianTayan, Researcher, GSB Corporate Governance Research Program/MBA ’03.

Overview: A well-functioning governance system consists of more than just the board of directors and the external auditor. It includes all disciplining mechanisms—legal, regulatory, and market driven—that influence management to act in the interest of shareholders.

Examples include:

-Labor market. Failure leads to CEO termination.

-Capital market. Failure leads to higher cost of capital.

-Regulatory environment. Violations lead to litigation.

Similarly, the “market for corporate control” puts pressure on the CEO to perform, or risk sale of company to new owners.

The entire series of presentations, to date, can be found here: http://www.gsb.stanford.edu/cgrp/research/powerpoint_presentations.html

• CGRP15 – Tesla (PDF) by Authors: Professor David F. Larcker and Brian Tayan, MBA ’03

In June 2010, Tesla Motors raised over $225 million in an initial public offering that valued the electric car manufacturer at $2 billion.  It was the first time a U.S. automobile company went public since Ford Motor in 1956.

The evolution of Tesla—first incorporated in 2003 by engineers Martin Eberhard and Marc Tarpenning—in some ways has been unique, given the nature of its business.  At the same time, Tesla has faced organizational challenges that are common to most public and private corporations.

We examine the prominent features of the company’s governance system as it has evolved from inception to IPO, including the board of directors, antitakeover protections, and executive compensation program.  In each case, the system changed to match the current needs of the company.

We ask:

• Many experts prescribe a one-size-fits-all approach to governance.   Why don’t they do a better job of taking into account the company’s specific situation and needs?
• Now that Tesla is public, how might we expect its governance system to change in the future?

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

Topics, Issues and Controversies in Corporate Governance: 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. To see the full series of  Stanford Closer Looks go here.

STANFORD, Calif. — May 09, 2011

Many institutional investors rely on a proxy advisory firm to assist them in voting company proxies and fulfilling the fiduciary responsibility they have to vote in the interest of beneficial shareholders. But according to a new study at the Stanford Graduate School of Business, proxy advisory firm recommendations may actually decrease shareholder value.

The recommendation of proxy advisory firms is not inconsequential. Studies conducted by Stanford GSB faculty member David F. Larcker, who is Director of the Corporate Governance Research Program, and doctoral students Allan L. McCall and Gaizka Ormazabal, show that an unfavorable recommendation from the largest proxy advisory firm (Institutional Shareholder Services, ISS) can reduce shareholder support significantly, depending on the matter of the proposal.

While there are potential benefits and drawbacks to relying on the voting recommendations of proxy advisory firms, little empirical research to date has been performed on whether the voting recommendations of these firms are “correct.” That is, are shareholders really better off if they follow their recommendations?

To answer this question the researchers examined the impact of ISS voting policies on 264 exchange offers during 2004 to 2009. They find that companies that design their exchange offer so that it receives a positive recommendation from proxy advisory firms exhibit a statistically lower market reaction, lower operating performance, and higher executive turnover than those firms that do not design their plans in accordance with the proxy advisory firm guidelines. These results indicate that proxy advisory firm recommendations on stock option exchanges do not increase, and in fact actually decrease, shareholder value.

The research paper, “Proxy Advisory Firms and Stock Option Exchanges: The Case of Institutional Shareholder Services,” and companion case study, “Do ISS Voting Recommendations Create Shareholder Value?” are available online from the Stanford Corporate Governance Research Program: http://www.gsb.stanford.edu/cgrp/topics/shareholder/closer_look.html.

Larcker is coauthor, with Brian Tayan, of the book, “Corporate Governance Matters: A Closer Look at Organizational Choices and their Consequences” (FT Press-Pearson Prentice Hall, 2011).

Contact:

Stanford Graduate School of Business
Helen Chang, 650-723-3358
chang_helen@gsb.stanford.edu

The Resignation of David Sokol: Mountain or Molehill for Berkshire Hathaway? (PDF)
by Authors: Professor David F. Larcker and Brian Tayan, MBA ’03

Additional related information:
-Berkshire Hathaway Audit Committee Report (Link)
-Questions and Answers From 2011 Annual Shareholders Meeting (Link)

Given its size, Berkshire Hathaway has had a relatively clean record on governance-related matters. This track record speaks to the quality of its governance system and the ability of its “trust-based” model to work.

For these reasons, it came as a shock to many when Warren Buffett announced the sudden resignation of David Sokol in March 2011.  Sokol, CEO of Berkshire Hathaway’s energy subsidiary, was widely considered the front-runner on a short list of potential successors to one day succeed Buffett.  More bizarre were the circumstances surrounding the announcement.  Just days before recommending to Buffett that Berkshire Hathaway purchase specialty chemical company Lubrizol in a $9.7 billion deal, Sokol accumulated common stock in Lubrizol worth $10 million.

The matter raised significant issues for the Berkshire board of directors:

1. Did Sokol violate the company’s insider trading policy?
2. Did Sokol’s actions reveal shortcomings in the company’s governance system that need to be addressed?
3. What will be the long-term impact of these events on company’s reputation?

More broadly, the matter raises questions that are general to all organizations.  How extensive must events be before a company decides that governance changes are required?

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

Topics, Issues and Controversies in Corporate Governance: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. To see the full series of  Stanford Closer Looks go here.