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.

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.

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.

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.

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 Debt Discipline Bankers? An Academic Myth About Bank Indebtedness  (SSRN)
Authors: Anat R. Admati, Stanford Graduate School of Business; and Martin  F. Hellwig, Max Planck Institute for Research on Collective Goods; University of Bonn – Department of Economics
Paper Date: February 10, 2013
Rock Center for Corporate Governance at Stanford University Working Paper No. 132 

Abstract:
Supplementing the discussion in our book The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It, this paper examines the plausibility and relevance of claims in banking theory that fragility of bank funding is useful because it imposes discipline on bank managers. The assumptions about information and about costs of bank breakdowns underlying these claims are unrealistic and they cannot be generalized without undermining the theory and policy prescriptions. The discipline narrative is also incompatible with the view that deposits and other forms of short-term bank debt contribute to liquidity provision; in this liquidity narrative, fragility of banks are a by-product of useful liquidity provision and can only be avoided by government support. We contrast both narratives with an explanation for banks’ avoidance of equity and reliance on short-term debt that appeals to debt overhang and government guarantees and subsidies for debt. In this explanation, fragility of banks arises from a conflict of interest and is neither useful for society nor unavoidable.

 Keywords: bank debt, bank equity, banking theory, fragility of bank funding, debt overhang

Boardroom Centrality and Firm Performance

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.

Abstract: 
Using Internet traffic patterns from the Securities and Exchange Commission Electronic Data-Gathering, Analysis, and Retrieval (EDGAR) website, we show that firms appearing in chronologically adjacent searches by the same individual are fundamentally similar on multiple dimensions. In fact, traffic-based peer firms identified by our algorithm significantly outperform peer firms based on six-digit Global Industry Classification Standard (GICS) groupings in explaining cross-sectional variations in base firms’ stock returns, valuation multiples, forecasted and realized growth rates, research and development expenditures, and various other key financial ratios. Our results highlight the usefulness of EDGAR data, as well as the latent intelligence in search traffic patterns.

Keywords: peer firms, EDGAR search traffic, revealed preference

–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!

Authors: Professor David F. Larcker, Stanford Graduate School of Business, and Brian Tayan, Researcher, Center for Leadership Development and Research, Stanford GSB.
Published: November 27, 2012

Shareholders of public companies are not responsible for designing executive compensation packages. Still, a shareholder vote on compensation is required in two circumstances:  when a company wants to establish an equity-based compensation plan, and annually as part of the Dodd Frank requirement shareholders have an advisory “say on pay.”  In deciding how to vote, shareholders rely on information provided in the annual proxy.

Recently, shareholder groups have sued companies for inadequate disclosure.  They allege that the companies provide insufficient disclosure to determine how they should vote on these matters.

We explore this issue in closer detail and ask:

• How much disclosure is too much disclosure?
• If a company follows SEC guidelines, why is this not sufficient?
• When do lawsuits cross the line from legitimate to frivolous?
• If disclosure litigation is successful, what other board decisions would be subject to potential lawsuits?

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

To view the entire collection of Stanford Closer Looks please click here. You can also follow more corporate governance and leadership news at @StanfordCorpGov and  @StnfrdLeadrship.

Authors: Professor David F. Larcker, Stanford Graduate School of Business, and Brian Tayan, Researcher, Center for Leadership Development and Research, Stanford GSB.
Published: November 13, 2012

Americans tend to admire powerful leaders.  Powerful leaders are seen as exerting influence over their organizations and shaping outcomes around them.  CEO power can be exercised across a wide spectrum of decisions, including those regarding corporate strategy, operations, acquisitions, organizational design, culture, and governance.

However, it is not clear the extent to which having a powerful CEO is beneficial to an organization.  CEO power can be positive or negative, depending how it is manifested and how it is exercised.

We examine this topic in greater detail, and ask:

•        Are shareholders better or worse off with a powerful CEO?
•        Where should the board draw the line between giving its CEO discretion and providing appropriate oversight?
•        How much power is too much power?

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

To view the entire collection of Stanford Closer Looks please click here. You can also follow more corporate governance and leadership news at  @StanfordCorpGov and  @StnfrdLeadrship .

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.

Abstract: 
We calculate increases in contributions required to achieve full funding of state and local pension systems in the U.S. over 30 years. Without policy changes, contributions would have to increase by 2.5 times, reaching 14.1% of the total own-revenue generated by state and local governments. This represents a tax increase of $1,385 per household per year, around half of which goes to pay down legacy liabilities while half funds the cost of new promises. We examine sensitivity to asset return assumptions, wage correlations, the treatment of workers not currently in Social Security, and endogenous geographical shifts in the tax base.

Keywords: pensions, state and local government, public finance

• What Do Corporate Directors and Senior Managers Know about Social Media?

Study by Stanford University’s Rock Center for Corporate Governance, in conjunction with The Conference Board, surveyed CEOs, senior executives, and corporate directors

STANFORD, Calif. — Less than a third of companies today use social media to support their corporate strategy and risk management practices, according to new research conducted by Stanford University’s Rock Center for Corporate Governance, the Center for Leadership Development and Research at the Stanford Graduate School of Business, and The Conference Board.

In the report titled “What Do Corporate Directors and Senior Managers Know about Social Media?” the authors detail the results of a survey of more than 180 senior executives and corporate directors of North American public and private companies. The findings reveal a disconnect between companies’ understanding of social media and the actions they are taking to apply it to their business. The report appears in the latest Directors Notes published by The Conference Board.

“Companies appreciate the potential that social media can have to transform all aspects of their business: branding, reputation, communication, outreach, and identifying strategic risks,” says Professor David F. Larcker of the Stanford Graduate School of Business and lead author of the study. “They also realize the serious threats that it can pose. They’re just not doing very much about it.”

“The world has changed, and consumers, employees, and stakeholders now expect to engage with companies and their brands through social media,” says Matteo Tonello, managing director of corporate leadership at The Conference Board. “That is why we are so pleased to be partnering with Stanford to support this research and help our membership better understand these evolving platforms.”

Conducted this summer, the survey included CEOs, senior executives, and directors across all major industries in the United States and Canada. Unlike most surveys on social media, which rely on a demographic of mostly young practitioners, the survey sample included only representatives from the highest levels of their respective organizations, with the average age of survey respondents in the mid-50s. Key findings include:

* While 90% of respondents claim to understand the impact that social media can have on their organization, only 32% of their companies monitor social media to detect risks to their business activities and 14% use metrics from social media to measure corporate performance.

* Only 24% of senior managers and 8% of directors surveyed receive reports containing summary information and metrics from social media. Approximately half of the companies do not collect this information at all.

* Nearly two-thirds of respondents (65%) use social media for personal purposes, and 63% for business purposes. Of those who use social media, 80% have a LinkedIn account and 68% have a Facebook account, demonstrating that executives and board members are familiar with this medium.

* Still, only 59% of companies in the survey use social media to interact with customers, 49% to advertise, and 35% to research customers. Approximately 30% use social media to research competitors, research new products and services, or communicate with employees and other stakeholders.

“We know that executives and board members are using social media. However, familiarity with social media is just not translating into systemic use at their companies,” Larcker explains. According to Larcker, the most frequently cited explanation for this gap is a lack of knowledge about how to set up a system to collect and distill information from social media into a useable form.

“The majority of those we surveyed don’t have social media guidelines in place at their companies, haven’t had a social media expert consult with their company, and don’t have systems in place for gathering key information. They are putting themselves at serious risk by not taking action,” Larcker concludes.

The study’s authors recommend that companies take the following steps to implement a social media strategy that integrates with their corporate strategy and risk management program:

1. Assess their current capabilities with social media
2. Determine how social media fits with their strategy and business model
3. Map their companies’ key performance indicators and risk factors to information available through social media
4. Implement a “listening” system to capture social media data and transform it into metrics
5. Develop formal policies and guidelines for employees, executives, and directors
6. Consider the legal and behavioral ramifications that could be involved if the company’s board receives summary data about social media

FOR FURTHER INFORMATION

Katie Pandes, Stanford Graduate School of Business, 650-724-9152,  pandes_katie@gsb.stanford.edu

Peter Tulupman, The Conference Board, 212-339-0231,  peter.tulupman@conference-board.org

Abstract: This paper examines how different types of interactions with U.S. markets by non-U.S. firms are associated with higher level of CEO pay, greater emphasis on incentive-based compensation, and smaller pay gap with U.S. firms. Using a sample of CEOs of U.K. firms and using both broad cross-sectional and narrow event-window tests, we find that capital market relationship in the form of an U.S. exchange listing is related to higher U.K CEO pay; however, the effect is similar when U.K. firms have a listing in any foreign country implying a foreign listing effect not unique to the U.S. Product market relationships measured by the extent of sales in the U.S. by U.K. companies are associated with higher pay, greater use of U.S.-style pay arrangements, and a reduction in the U.S.-U.K. pay gap. The product market effect is incremental to the effect of a U.S. exchange listing, the extent of the firm’s non-U.S. foreign market interactions, and the characteristics of the executive. The U.S-U.K. CEO pay gap reduces in U.K. firms that make U.S. acquisitions. Further, the firm’s use of a U.S. compensation consultant increases the sensitivity of U.K. pay practices to U.S. product market relationships.

Keywords: CEO compensation, international pay, globalization, corporate governance, incentives, cross-listing, United Kingdom

Abstract: 
Prior research argues that a manager whose wealth is more sensitive to changes in the firm’s stock price has a greater incentive to misreport. However, if the manager is risk-averse and misreporting increases both equity values and equity risk, the sensitivity of the manager’s wealth to changes in stock price (portfolio delta) will have two countervailing incentive effects: a positive “reward effect” and a negative “risk effect.” In contrast, the sensitivity of the manager’s wealth to changes in risk (portfolio vega) will have an unambiguously positive incentive effect. We show that jointly considering the incentive effects of both portfolio delta and portfolio vega substantially alters inferences reported in prior literature. Using both regression and matching designs, and measuring misreporting using discretionary accruals, restatements, and SEC Accounting and Auditing Enforcement Releases, we find strong evidence of a positive relation between vega and misreporting and that the incentives provided by vega subsume those of delta. Collectively, our results suggest that equity portfolios provide managers with incentives to misreport when they make managers less averse to equity risk.

Keywords: Equity Incentives, Executive Compensation, Misreporting, Earnings Management, Restatements, SEC Enforcement Actions

Corporate monitors are important participants in corporate governance systems.  Monitors include the board of directors, the general counsel, and internal and external auditors.  Monitors are paid by the organization but their responsibilities largely or mostly non-managerial.

How should monitors be paid?  Because their objective is to detect and mitigate agency problems, one could argue that they should be paid almost entirely on a fixed-salary basis.  On the other hand, an entirely fixed compensation system might not provide sufficient incentive to perform.

We discuss this issue in greater detail.  We ask:

• Should corporate monitors be paid a bonus?
• If so, what form should it take?
• What performance targets should be used to calculate the bonus?
• Do performance incentives enhance or impede the effectiveness of monitors?

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

To view the entire collection of Stanford Closer Looks please click here. You can also follow more corporate governance and leadership news at @StanfordCorpGov and @StnfrdLeadrship.

Does the Gender of Directors Matter?
Abstract:   How does gender-balance affect the working of boards of directors? I examine boards that have been required for two decades to be 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 board-committee meetings of eleven such companies. I find that boards that had critical masses of at least three directors of each gender in attendance, and particularly of three women, were approximately twice as likely both to request further information and to take an initiative, compared to boards that did not have such critical masses. A 2sls model confirms these results. Consistent with these findings, the ROE and net profit margin of these type of companies is significantly larger in companies that have at least three women directors. At the level of the individual directors, men and especially women directors were more active when at least three women directors were in attendance. In addition, women directors were found to be more likely than men directors to take actions concerning supervisory issues.

Other board related paper:
What Do Boards Really Do? Evidence from Minutes of Board Meetings 
Charles A. Dice Working Paper No. 2011-19, Fisher College of Business Working Paper No. 2011-03-19, Miriam Schwartz-Ziv and Michael S. Weisbach , Hebrew University of Jerusalem – Department of Finance and Banking and Ohio State University (OSU) – Department of Finance.

Abstract:  The prevailing view among many economists is that derivatives markets simply enable financial markets to incorporate information better and faster. Under this view, increasing the size of derivatives markets only increases the efficiency of financial markets.  We present formal economic analysis that contradicts this view. Derivatives allow investors to hold economic interests in a corporation without owning voting rights, or vice versa. This leads to both empty voters — investors whose voting rights in a corporation exceed their economic interests — and hidden owners — investors whose economic interests exceed their voting rights. We show how, when financial markets are opaque, empty voting and hidden ownership can render financial markets unpredictable, unstable, and inefficient. By contrast, we show that when financial markets are transparent, empty voting and hidden ownership have dramatically different effects. They cause financial markets to follow predictable patterns, encourage stable outcomes, and can improve efficiency. Our analysis lends insight into the operation of securities markets in general and derivatives markets in particular. It provides a new justification for a robust mandatory disclosure regime and facilitates analysis of proposed substantive securities regulations.

SSRN Abstract:  Intuition suggests that firms with higher cash holdings should be ‘safer’ and have lower credit spreads. Yet empirically, the correlation between cash and spreads is robustly positive. This puzzling finding can be explained by the precautionary motive for saving cash, which in our model causes riskier firms to accumulate higher cash reserves. In contrast, spreads are negatively related to the part of cash holdings that is not determined by credit risk factors. Similarly, although firms with higher cash reserves are less likely to default in the short term, endogenously determined liquidity may be related positively to the longer-term probability of default. Our empirical analysis confirms these predictions, suggesting that precautionary savings are central to understanding the effects of cash on credit risk.

Fair Value Accounting for Financial Instruments: Does it Improve the Association Between Bank Leverage and Credit Risk? (link to Social Science Research Network (SSRN))

Follow Anat Admati on Twitter: https://twitter.com/anatadmati  @anatadmati

The Economic Consequences of Proxy Advisor Say-on-Pay Voting Policies
Authors: David F. Larcker, Stanford University – Graduate School of Business; Allan L. McCall, Stanford University – Graduate School of Business; Gaizka Ormazabal,IESE Business School of the University of Navarra
Published: July 5, 2012
Rock Center for Corporate Governance at Stanford University Working Paper No. 119 

Abstract: 
This paper examines changes in executive compensation programs made by firms in response to proxy advisory firm say-on-pay voting policies. Using proprietary models, proxy advisory firms, primarily Institutional Shareholder Services and Glass, Lewis & Co., provide institutional shareholders with a “for” (positive) or “against” (negative) recommendation on the required management say-on-pay proposal in the annual proxy statement.
Analyzing a large sample of firms from the Russell 3000 that are subject to the initial say-on-pay vote mandated by the Dodd-Frank Act, we find three important results.

First, proxy advisory firm recommendations have a substantive impact on say-on-pay voting outcomes. Second, a significant number of firms change their compensation programs in the time period before the formal shareholder vote in a manner consistent with the features known to be favored by proxy advisory firms apparently in an effort to avoid a negative recommendation. Third, the stock market reaction to these compensation program changes is statistically negative. Thus, the proprietary models used by proxy advisory firms for say-on-pay recommendations appear to induce boards of directors to make choices that decrease shareholder value.

Number of Pages in PDF File: 59

Keywords: proxy advisory firms, say-on-pay, institutional shareholder voting

Say on pay is the practice of granting shareholders the right to vote on a company’s executive compensation program at the annual shareholder meeting.  Under the Dodd-Frank Act of 2010, publicly traded companies in the U.S. are required to adopt say on pay.  Advocates of this approach believe that say on pay will increase the accountability of corporate directors and lead to improved compensation practices.

In recent years, several myths have come to be accepted by the media and governance experts.  These myths include the beliefs that:

1. There is only one approach to “say on pay”
2. All shareholders want the right to vote on executive compensation
3. Say on pay reduces executive compensation levels
4. Pay plans are a failure if they do not receive high shareholder support
5. Say on pay improves “pay for performance”
6. Plain-vanilla equity awards are not performance-based
7. Discretionary bonuses should not be allowed
8. Shareholders should reject nonstandard benefits
9. Boards should adjust pay plans to satisfy dissatisfied shareholders
10. Proxy advisory firm recommendations for say on pay are correct

We examine each of these myths in the context of the research evidence and explain why they are incorrect.

We ask:

* Should the U.S. rescind the requirement for mandatory say on pay and return to a voluntary regime?

Read the attached 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.

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.  

Susan Singer, SCPM

(For questions or feedback contact Susan at:  singerscpm@gmail.com)

Veteran journalist Bill Moyers recently wrote an article with Michael Winship, president of the Writers Guild of America, East; entitled “Money Throws Democracy Overboard,” the piece focuses on the role of Super PACs in the 2012 US presidential election cycle. However, the authors quote economist Frederic Bastiat in concluding “[w]hen plunder becomes a way of life for a group of men living in society, they create for themselves, in the course of time, a legal system that authorizes it and a moral code that glorifies it.” ¹

The quote can be paraphrased to apply to an organization’s governance arising out of its culture. When specific behaviors, memes, or iconic leaders predominate, these will be codified in the governance authorizing and glorifying them as policy.

Professor Gideon Kunda, in a lecture at Stanford University some years ago, noted that culture is a learned body of tradition within a society or microcosm thereof; it consists of concrete, observable artifacts and the complex set of rules that arise from the artifacts’ interpretation. Every workplace has a culture in which causal structures drive the organization and in which managers make predictions and take actions based on those structures. The structure, the culture and the corporate entity’s engagement in and responses to its environment become codified; how it is done is often reflective of its highest echelon. (Schein²; Deal & Kennedy³)

Corporate cultures usually originate with the company’s founder, or with a long-time or especially influential CEO. Examples of these include Southwest Airlines’ Herb Kelleher, who encouraged a relaxed and “fun” environment while, at the same time, running an efficient operation that could turn around a recently-landed aircraft inside of 20 minutes. Richard Branson is of this mold also; having somewhere around 300 ventures running under the Virgin umbrella, he delegates authority, entrusting important business decisions and, indeed, entire operations to individuals who share his values of “doing well by doing good” and, more recently (as his latest book’s title attests), “screwing business as usual”.

John Richard Bell, in his article “Why Directors Should Give a Damn About Culture”⁴, says:

“Imagine Apple without innovators or Zappos neglecting service or Whole Foods selling a slew of processed foods loaded with saturated fat. Generally, founders instill the culture. And when they are long gone, the culture is left to the CEO to nurture. He or she perpetuates ‘the way’ or makes changes depending on the environment… I am simply advocating that culture should be as important to a company’s Board of Directors as the business strategy. After all, culture is the strategy.”

In his 1984 tome Endless Enemies: The Making of an Unfriendly World, Jonathan Kwitny details numerous examples of corporate culture – and thus policy – run amok. Dole and United Brands, among others, effectively leveraged their power to influence US international policy, giving rise to the so-called Banana Republics. Kwitny, in an appearance at the Center for the Study of Democratic Institutions in 1985 said:

“In 1954, UN Ambassador Henry Cabot Lodge lied to…cover up the overthrow…of a democratically chosen government in Guatemala that was seeking to break up the United Brand monopoly; he…concealed the fact that his family were major shareholders of United Brands and that his cousin was a recent president of that company.

I think Henry Cabot Lodge believed that what was good for General Motors – or in this case United Brands – was good for the country.” ⁵

The corporate culture described in the book was supported by governance that legitimated collusion and, in Kwitny’s estimation at least, violated free market principles to the detriment of the citizen. It was also a culture in which executives were “fattening their wallets” through close association with and intense pressure on government officials. No consideration was given to what is now termed Corporate Social Responsibility (CSR).

Fast-forwarding through time, the results of a 2011 governance survey conducted by the National Association of Corporate Directors⁶ still demonstrates that a small percentage (1.5%) of corporate directors value the concept of Corporate Social Responsibility. The same survey found that just over 11% of the respondents’ boards collected data that would allow them to objectively assess ethical risk; boards expressed a sense that disclosure and reporting requirements are “excessive”.

The tide may be shifting, however. In that same year, Forbes Corporate Responsibility Best Practices Study found an increase in the number of firms having a CSR policy (defined as maximizing positive impact while minimizing or eliminating the negative). Likewise, the vast majority (86%) of CEOs believe that Corporate Responsibility is an issue of great importance⁷.

Returning to the Virgin Group, their website states that

“Virgin Group companies are part of one big family rather than a hierarchy. They are empowered to run their own affairs, yet the companies actively help one another, and solutions to problems are often sourced from within the Group. In a sense they form a commonwealth, with shared ideas, values, interest and goals.”

This would indicate a significant – although still a minority view – shift in the corporate governance paradigm. In the conventional model, rules that arise from organizations’ cultural artifacts are expressed through hierarchy, peer groups, centrality, relationships and environment. The Virgin model, by contrast, runs counter to the majority of these expressions.

There are other signs of movement toward cultures of more transparent and effective governance. In the article How High CEO Pay Hurts the 99% ⁸, UMass Professor William Lazonick and journalists Ken Jacobson and Lynn Parramore aver that top US executives “rake in obscene sums by not doing their jobs” and delve into how the public might “take control of the business corporation and make it work for the real economy”. Tackling the “runaway compensation train” and accountability within corporations’ environments would demand entirely different governance and accountability protocols than are being currently employed.

Boards of Directors are being down-sized, modernized and reformulated. They are codifying these changes in their governance and they are responding in varying degrees to the almost-daily articles ranging in subject matter to the benefits of diversity, gender balance, and CSR / Shared Value ^{9, 10, 11}. Tim Carmody, writing for Wired stated: “no matter how successful a company or its stock has become, or how visionary its leadership, investors want input into corporate governance.” This sentiment has translated into yet another paradigm shift as evidenced at an Apple shareholders’ meeting. Henceforth, stockholders will directly elect the board of directors by simple majority vote. Current directors who do not achieve majority vote will be forced to resign and the company’s governance has been amended to codify this change! ¹²

In the last year, there have been numerous debates as to whether the practice of having the CEO also chair the board and how to potentially utilize succession planning as a catalyst for evolution ¹³. To spur the evolution of governance along, new organizations are springing up to offer resources to companies seeking them; one such entity, BoardProspects, has adopted the mission of matching prospective board members to appropriate corporations or non-profits. It will, when launched in May 2012, offer tools and educational materials to “propel [boards] into the future” and improve governance. Another organization known as Great Boards determined ten elements to be considered in succession planning; these include objective, metric or evidence-based criteria such as competencies evaluations and skills gap analyses. The protocol also calls for performance-based re-election in addition to term limits.

Board composition can be transformational and there appears to be a redshifting from representational governance to a systems thinking approach. The paradigm that was in play for most of the twentieth century is often viewed as less effective, less transparent, less ethical and less nimble in its ability to support twenty-first century enterprise. Entrepreneurs and innovators are re-writing the rules for conducting business; citizens are demanding a say in the matter. As a culture of transparency, balance and citizenship builds in, it will be codified over time in the governance authorizing and glorifying these values as policy.

CITATIONS

¹ Common Dreams. “Money Throws Democracy Overboard” Bill Moyers and Michael Winship, February 14, 2012. http://www.commondreams.org/view/2012/02/14-4

² Schein, Edgar H. (2010) Organizational Culture and Leadership, 4^th Edition John Wiley & Sons, San Francisco

³ Deal T. E. and Kennedy, A. A. (1982, 2000) Corporate Cultures: The Rites and Rituals of Corporate Life, Harmondsworth, Penguin Books, 1982; reissue Perseus Books, 2000

⁴ In the CEO Afterlife. “Why Boards Should Give a Damn About Culture” John Richard Bell, May 1, 2012. http://www.ceoafterlife.com/leadership/culture-and-boards/

⁵ Center for the Study of Democratic Institutions, 1985. “Use of the Lie in U.S. Foreign Policy” Jonathan Kwitny http://www.cooperativeindividualism.org/kwitny-jonathan_usa-foreign-policy-history.html (accessed May 2012)

⁶ National Association of Corporate Directors. “2011 Public Company Governance Survey” http://www.nacdonline.org/Store/ProductDetail.cfm?ItemNumber=3854

⁷ Forbes “Where CSR Fits on the Board’s Agenda” Richard Crespin, February 10, 2012. http://www.forbes.com/sites/csr/2012/02/10/where-csr-fits-on-the-boards-agenda/

⁸ AlterNet. “How High CEO Pay Hurts the 99%” William Lazonick, April 2, 2012. http://www.alternet.org/economy/154746/how_high_ceo_pay_hurts_the_99_percent?page=entire

⁹ Reuters. “Why Facebook – and Every Company – Needs a Diverse Board” Lucy P. Marcus, February 8, 2012. http://blogs.reuters.com/lucy-marcus/2012/02/08/why-facebook-and-every-company-needs-a-diverse-board/

¹⁰ CNN. “More Women Needed in ‘Identikit Boardrooms,’ Says CEO” Juliet Mann, February 9, 2012. http://edition.cnn.com/2012/02/09/business/women-in-the-boardroom/index.html

¹¹ US Chamber of Commerce, Business Civic Leadership Center. “So What About the Board?” Nigel M. de S. Cameron http://bclc.uschamber.com/blog/2012-01-11/so-what-about-board (accessed May 14, 2012).

¹² Wired. “Apple Gives Shareholders More Input; Will Facebook Get the Message?”  Tim Carmody, February 24, 2012. http://www.wired.com/epicenter/2012/02/apple-gives-shareholders-more-input-will-facebook-get-the-message/

¹³ Harvard Law School Forum on Corporate Governance and Financial Regulation. “Top Concerns for Directors in 2012” Noam Noked, March 24, 2012. http://blogs.law.harvard.edu/corpgov/2012/03/24/top-concerns-for-directors-in-2012/

Misc. Interesting Video Resources on the Web

Bob Sutton vid on organizational behavior

http://myvideos.stanford.edu/player/slplayer.aspx?coll=62f91f06-f34e-43fb-b1e9-25f455cc2223&co=bab57573-2737-4ca1-891c-805c3e43709d&w=true

Failing to Success http://blogs.hbr.org/video/2012/04/failing-to-success.html?awid=8068275453268138925-3271

Boards, shareholders, and journalists often look at a chief executive’s annual compensation plan to determine whether the company is offering the right incentives to increase shareholder value. Few consider another key question: how does the compensation that the CEO has already received over the years in the form of stock and stock options influence managerial decision making?

ABOUT THE EVENT:

Please come join us for a panel discussion with three successful lawyers-turned-venture capitalists about venture capital and how your legal education can help you get into this career path.

ABOUT THE PANEL:

·   Josh Green - General Partner, Mohr Davidow

In a 25-year career in law, Josh acted as an advisor to some of Silicon Valley’s legendary startups in the computer, Internet, telecommunications, biotech and medical device industries. Josh gained a breadth of knowledge that makes him uniquely qualified for an investment area that spans multiple industries. He has helped more than 150 companies complete successful IPOs, worked with Cerent in the largest technology acquisition in Cisco’s history ($8 billion) and partnered closely with companies such as Yahoo! during their formative stages. Josh graduated magna cum laude from UCLA in 1977 and the UCLA School of Law in 1980 where he was on the Law Review.

·  Scott Kupor - Managing Partner, Andreessen Horowitz

Scott Kupor is the managing partner at Andreessen Horowitz. He previously worked as vice president and general manager of Software-as-a-Service at Hewlett Packard. Scott joined HP in 2007 as part of the Opsware acquisition, where he was senior vice president of Customer Solutions. Prior to Opsware, Kupor represented software companies in both financing and mergers and acquisitions transactions at Credit Suisse First Boston and Lehman Brothers. Scott graduated Phi Beta Kappa from Stanford University with a bachelor’s degree in public policy with honors and distinction. He also holds a law degree with distinction from Stanford University and is a member of the California Bar Association.

·  Miriam Rivera - Managing Director, Ulu Ventures

Miriam co-founded Ulu Ventures, where she is the Managing Partner.  Ulu is an early stage angel fund focused on IT investments and has made 30 investments in the last three years.  She is also the co-founder and co-president of Stanford Angels & Entrepreneurs, an “open source network” of Stanford alumni investors and entrepreneurs.  Miriam has taught in the Stanford Technology Ventures Program in the School of Engineering on start-up board issues and is a mentor in entrepreneurship at the Stanford GSB.  She is also a Kauffman Fellow in venture capital.  As a first generation college student and scholarship recipient, Miriam graduated from Stanford University where she earned the AB, AM, and JD/MBA degrees.

This event is open public and registration is free.  Click here to register.

The following glossary of terms are frequently used in discussions of corporate governance. Link the Stanford Corporate Governance Research Program glossary of terms to your website:  http://www.gsb.stanford.edu/cgrp/research/glossary

Monitoring Risks Before They Go Viral: Is it Time for the Board to Embrace Social Media?
Authors: Professor David F. Larcker, Sarah M. Larcker and Brian Tayan, Researcher, Corporate Governance Research Program, Stanford Graduate School of Business.
Published: April 5,  2012

According to Nielsen, social networks and blogs account for the largest percentage of time that individuals spend online, more than email and reading the news.  Given the pervasiveness of social media and the potential impact it can have on corporate activities, some experts recommend that boards of directors pay closer attention to the information exchanged on these sites.

Information gleaned through social media might provide unique and relevant insights that improve decision making.  For example, this information might be used to supplement the traditional key performance indicators that boards use to monitor corporate performance.  Similarly, it might also be used as an “early warning” system to improve risk management.

In this closer look, we examine these issues in detail.  We ask:

• Why haven’t more boards utilized information from social media to improve corporate oversight?
• Should the board formally review social media metrics, or does this represent an encroachment on management?
• Can this information be used to safeguard corporate reputation?

Read the attached 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.

Debt Overhang and Capital Regulation
Rock Center for Corporate Governance at Stanford University Working Paper No. 114 MPI Collective Goods Preprint, No. 2012/5 (Social Science Research Network)
Paper Date: March 23, 2012
Authors:
Anat R. Admati, Stanford Graduate School of Business;
Peter M. DeMarzo, Stanford Graduate School of Business; National Bureau of Economic Research (NBER);
Martin F. Hellwig, Max Planck Institute for Research on Collective Goods; University of Bonn – Department of Economics;
Paul C. Pfleiderer, Stanford Graduate School of Business

Abstract: 
We analyze shareholders’ incentives to change the leverage of a firm that has already borrowed substantially. As a result of debt overhang, shareholders have incentives to resist reductions in leverage that make the remaining debt safer. This resistance is present even without any government subsidies of debt, but it is exacerbated by such subsidies.

Our analysis is relevant to the debate on bank capital regulation, and complements Admati et al. (2010). In that paper we argued that subsidies that favor debt over equity are the key reason that banks funding costs would be lower if they “economize” on equity. Subsidies come from public funds, and reducing them does not represent a social cost. It is thus irrelevant for assessing regulation. Other arguments made to support claims that “equity is expensive” are flawed.

Like reduction in subsidies, the effects of leverage reduction on bank managers or shareholders do not represent a social cost. In fact, we show that debt overhang creates inefficiency, since shareholders would resist recapitalization even when this would increase the combined value of the firm to shareholders and creditors. Moreover, debt overhang creates an “addiction” to leverage through a ratchet effect. In the presence of government guarantees, the inefficiencies of excessive leverage are not fully reflected in banks’ borrowing costs.

Since banks’ high leverage is a source of systemic risks and imposes costs on the public, resistance to leverage reduction leads to social inefficiencies. The main beneficiaries from high leverage may be bank managers. The majority of the banks’ shareholders, who hold diversified portfolios and who are part of the public, are likely to be net losers. Our analysis highlights the critical importance of effective capital regulation and high equity requirements, especially for large and “systemic” financial institutions.

We analyze shareholders’ preferences when choosing among various ways leverage can be reduced. We show that, with homogeneous assets, if the firm’s security and asset trades have zero NPV, and the firm has a single class of debt outstanding, then shareholders find it equally undesirable to deleverage through asset sales, pure recapitalization, or asset expansion with new equity. When these conditions are not met, shareholders can have strong preferences for one approach over another. For example, if the firm can buy back junior debt, asset sales are the preferred way to reduce leverage. This preference for asset sales, or “deleveraging,” can persist even if such sales are inefficient and reduce the total value of the firm.

 Keywords: capital regulation, financial institutions, capital structure, “too big to fail,” systemic risk, bank equity, debt overhang, underinvestment, recapitalization, deleveraging, bankruptcy costs, Basel.

JEL Classifications: G21, G28, G32, G38, H81, K23

Shareholder Activism: How It Began and How It’s Reshaping Today’s Investment Landscape. Three part Series with Mason Morfit, ValueAct Capital and Abe Friedman, former Global Head of Corporate Governance & Responsible Investment for BlackRock

Click here to RSVP

Please join us for an overview of shareholder activism in a three part series, beginning with the history and an overview of the key players in the space; continuing with a behind-the-scenes look at non-contentious shareholder engagement and how it is impacting companies and the market; and ending with an overview of proxy fights, PR wars and activist defense.

Mason Morfit, a partner at ValueAct Capital and one of the most successful shareholder activists in the US, and Abe Friedman, former Global Head of Corporate Governance & Responsible Investment for BlackRock, the world’s largest asset manager, will share insights from their experience in the trenches engaging every day with management teams and boards on behalf of investors.  In addition, they will offer insights on activism globally, how activism in the US is changing and what that means for corporate America in the next decade.

5:30 pm Reception
6:00 pm – 7:00 pm Session

Monday April 16: Activist Investing: Background, Impact and the Players
Stanford Law School, Room 190

Monday, April 23: Non-contested situations in activism and behind-the-scenes influence
Stanford Graduate School of Business, N302

Monday, April 30: Contested Situations: Proxy Fights, PR wars and activist defense
Stanford Law School, Room 190

• The Influence of Proxy Advisory Firm Voting Recommendations  on Say-on-Pay Votes and Executive Compensation Decisions by David F. Larcker, Allan L. McCall, and Brian Tayan, Stanford Graduate School of Business and Rock Center for Corporate Governance

This report examines current evidence regarding the influence of third-party proxy advisory firms’ voting recommendations on shareholder proposal voting outcomes, particularly say-on-pay votes. It also presents the findings of a study, conducted by The Conference Board, NASDAQ, and the Rock Center for Corporate Governance at Stanford University, which shows that proxy advisory firms have a substantial impact on the design of executive compensation programs.  Read the entire study results in the link above.

Sudden Death of a CEO: Are Companies Prepared When Lighting Strikes? (PDF)
By Professor David F. Larcker and Brian Tayan, Researcher, Corporate Governance Research Program, Stanford Graduate School of Business.
Published: March 6, 2012

It is very difficult for shareholders to know detailed information about CEO succession planning among the companies they have invested in.  Although CEO deaths are rare, the sudden death of a CEO can provide insight into the quality of succession planning and governance of a company.  Whereas some companies are able to appoint a successor immediately, others take weeks or months to do so.

In this Closer Look, we examine this issue in detail.

We ask:

* Why haven’t more companies done a “reality check” on whether they have a truly operational succession plan?
* What can a board learn and what should it do if the market reacts positively to the death of its CEO?
* Should the board revise its succession plan if its CEO engages in risky hobbies or lifestyle habits?

Read the attached 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.

Failure is an Option: Failure Barriers and New Firm Performance

Authors:  Robert Eberhart , Stanford University – Management Science & Engineering; Stanford University Shorenstein APARC / SPRIE;  Charles E. Eesley , Stanford University and, Kathleen M. Eisenhardt  Stanford University – Management Science & Engineering;
Working Paper Date: February 7, 2012
Rock Center for Corporate Governance at Stanford University Working Paper No. 111 

Abstract: 
Do bankruptcy changes in the institutional environment affect the rate of founding by particular types of founders and the performance of their ventures? We take advantage of a natural experiment in Japan where during the last decade Japan implemented legal reforms to revive Japan’s economic fortunes by changes to bankruptcy laws that reduced the consequences of closing a firm. We argue that lowered costs of exit may have attracted individuals with greater human capital and social networks thus positively affecting new firm performance. We argue and test whether making it easier to fail will attract more founders and higher human capital founders resulting in improved firm performance.

Our findings are: as expected the bankruptcy rate increases but at a higher rate for high human capital individuals, the rate of startup firms increases for older and elite educated entrepreneurs, and these groups of entrepreneurs are more likely to found higher performing firms. Overall, while prior research emphasizes the lowering of entry barriers, our work shows that reducing the costs of failure can also stimulate venture formation among certain groups, and lead to forming higher performing firms.

To access all the papers in this series please use the following URL: http://www.ssrn.com/link/Rock-Center-RES.html  May require free subscription. Distributed by: Corporate Governance Network (CGN), a division of Social Science Electronic Publishing (SSEP) and Social Science Research Network (SSRN)

• What Is CEO Talent Worth?  (PDF)
  By Professor, David F. Larcker and Brian Tayan, Researcher, Corporate Governance Research Program, Stanford Graduate School of Business, and Usman Liaqat
  January 24, 2012

The topic of executive compensation elicits strong emotions among corporate stakeholders and practitioners. On the one hand are those who believe that chief executive officers in the United States are overpaid. On the other hand are those who believe that CEOs are simply paid the going fair-market rate.

Much less effort, however, is put into determining whether total compensation is commensurate with the value of services rendered.

We examine the issue and explain how such a calculation might be performed. We ask:

* How much value creation should be attributable to the efforts of the CEO?
* What percentage of this value should be fairly offered as compensation?
* Can the board actually perform this calculation? If not, how does it make rational decisions about pay levels?

Read the attached 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.

• What Does It Mean for an Executive To Make $1 Million? (PDF)
  By Professor, David F. Larcker,  Allan L. McCall, Stanford GSB Phd candidate in accounting, and Brian Tayan, Researcher, Corporate Governance Research Program, Stanford Graduate School of Business
  December 14, 2011
• Companion PowerPoint presentation for use in teaching:  What Does It Mean for an Executive To “Make” $1 Million? (PowerPoint)

The press and other third-party observers frequently discuss executive compensation.  However, executive compensation figures are not always what they seem.  Executive pay packages contain a diverse mix of cash and non-cash incentives, payable in one or multiple years and subject to accruals, estimates, and restrictions that often render their ultimate value quite different from their expected value.  Even total compensation figures disclosed in the annual proxy comingle forward- and backward-looking amounts as well as fixed and contingent payments that make it difficult for investors to understand what compensation has been promised to executives and what they eventually earn.

We untangle the mess and examine three basic methods for calculating compensation: expected value, earned value, and realized value.

We discuss the applicability of each, illustrating concepts with real examples and summary statistics.

Why don’t companies voluntarily disclose these figures so stakeholders can better evaluate incentives and pay for performance?

Read the attached 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.

CEO Preferences and Acquisitions

Dirk Jenter 
Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Katharina Lewellen 
Dartmouth College – Tuck School of Business

December 2011

Rock Center for Corporate Governance at Stanford University Working Paper No. 105

Abstract: 
This paper explores the impact of target CEOs’ retirement preferences on the incidence, the pricing, and the outcomes of takeover bids. Mergers frequently force target CEOs to retire early, and CEOs’ private merger costs are the forgone benefits of staying employed until the planned retirement date. Using retirement age as an instrument for CEOs’ private merger costs, we find strong evidence that target CEO preferences affect merger patterns. The likelihood of receiving a takeover bid increases sharply when target CEOs reach age 65. The probability of a bid is close to 4% per year for target CEOs below age 65 but increases to 6% for the retirement-age group, a 50% increase in the odds of receiving a bid. This increase in takeover activity appears discretely at the age-65 threshold, with no gradual increase as CEOs approach retirement age. Moreover, observed takeover premiums and target announcement returns are significantly lower when target CEOs are older than 65, reinforcing the conclusion that retirement-age CEOs are more willing to accept takeover offers. These results suggest that the preferences of target CEOs have first-order effects on both bidder and target behavior.

Keywords: takeover bids, CEO retirement preferences and acquisitions, mergers & acquisitions

 JEL Classifications: G32, G34, G35

Note: The following guest blog posting is from Miriam Schwartz-Ziv and Michael S. Weisbach[1].  Miriam Schwartz-Ziv is from The Hebrew University of Jerusalem and Harvard University. Michael S. Weisbach is from Ohio State University, NBER, and SIFR.

What do Boards Really Do? Evidence from Minutes of Board Meetings

 Summary 

In recent years more than a dozen economic models have attempted to examine what board actually do. However, because board meetings are generally a “black box” to which scholars have very limited access, these models proceed from wildly different underlying assumptions, and accordingly, make very different predictions. These models generally fall into two categories:

(1)             “Managerial models” – assume boards play a direct role in managing the firm, and that they make the actual decisions pertaining to the business of the firm.

(2)              “Supervisory models” – assume that the board only observes the CEO’s actions, but does not make any business decisions. Based on the boards’ observations, it evaluates/reevaluates the CEO, and decides whether to retain or fire the CEO.

We evaluate the extent these models depict a reasonable reality and realistic board dynamics: we analyze a unique database from a sample of real-world boardrooms – minutes of board meetings and board-committee meetings of eleven business companies for which the Israeli government holds a substantial equity interest (GBCs).  This approach allows us to examine the day-to-day functions of boards.

Consistent with the supervisory models, our minutes-based data suggest that monitoring is the most common and typical work of boards: in our sample, 67% of the issues the boards discussed were of a supervisory nature, boards were presented with only a single option in 99% of the issues discussed, and at the voting phase they disagreed with the CEO only 3.3% of the time. Nevertheless, we find that managerial models describe a reality that also exists at times: Boards requested to receive further information or an update for 8% of the issues discussed, and they took an initiative with respect to 8.1% of them. Furthermore, in 63% of the meetings, boards took at least one of these actions or did not vote in line with the CEO, indicating that in most meetings boards are active, and take at least one action.

We also examine the extent of dissension among directors. In most economic models boards are modeled as a monolithic entity. We find support for this approach: in only 3.3% of the cases in the sample, boards did not vote unanimously.

The minutes data allows us to draw some inferences that are impossible to make using publicly available data. For example, our sample suggests that prior work understates the fraction of CEO departures that are “forced”. While our sample is too small to draw reliable estimates of the understatement, there are at least two cases in our sample  (from a total of four departing CEOs) where the CEO was clearly coerced to leave by the board, yet there would be no way to know about this coercion using only publicly available data. The existence of these cases suggest that estimates of the fraction of CEO turnovers that are forced using publicly-traded data will underestimate perhaps substantially, the fraction of turnovers that are initiated by the board.

Last, we find evidence that larger boards are more active – in our sample larger boards are more likely to request further information or an update. However, larger boards also seem to have more coordination problems, as reflected by their voting patterns: they were more likely not to reach a consensus by the voting phase – i.e. not to vote unanimously. In addition, the CEO was also less likely to receive the boards’ consent to his proposal in larger boards, perhaps, indicating that CEOs with larger boards are less able to align the board to their proposal prior to the board meeting.

A potential concern is the extent to which the boards of our sample of Israeli government-controlled companies reflect other companies. It is impossible to know exactly how different our firms’ governance is from that of privately held companies in both in Israel and the rest of the world. Nevertheless, like directors of privately-held companies, these directors still have a fiduciary responsibility to maximize their firm’s profits, and our reading of the minutes suggests that they take this responsibility seriously. Furthermore, as we specify throughout the paper, the board dynamics we document are similar to those reported in interview-based studies, which are most often based on publicly-traded U.S. companies. For these reasons, we believe that the relationship between a CEO and a GBC board, and among the directors of GBCs, is likely to be similar to the corresponding relationships in other boardrooms.

To understand the role of boards of directors, we believe it is necessary to observe to the extent possible how they actually function. This paper is the first to document in any systematic fashion what boards actually do. Hopefully future research will be able to perform similar analyses for other samples of companies.

The full paper is available for download here.

The Alsop Perspective: Getting More Women on BoardsStanford, along with a few other universities, is doing its part to promote such women and create more gender diversity on corporate boards. The schools are offering special educational programs, conducting research studies, and building databases of promising female candidates. Graduate Management News (November 2011)

•  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.

What would happen if the NCAA adopted Dodd-Frank?  Professor Bainbridge, 10/3/2011 [ http://www.professorbainbridge.com/professorbainbridgecom/2011/10/what-would-happen-if-the-ncaa-adopted-dodd-frank.html ]

• The NCAA Adopts “Dodd-Frank”: A Fable  (PDF)
  Stanford Graduate School of Business – Corporate Governance Research Program, Professor David F. Larcker and researcher Brian Tayan, MBA 2003

 In recent years, NCAA football has been rocked by a string of high-profile violations, including those at USC, Ohio State, the University of Miami, and Auburn.  In many ways, these violations were similar to the governance breakdowns at financial and other corporations leading up to the financial crisis of 2008 and 2009.

In the corporate world, Congress responded to the financial crisis by enacting the Dodd-Frank Wall Street Reform Act, which among other things imposed various governance requirements on all publicly traded companies.

What would happen were the NCAA to adopt these same provisions and require them of all universities and their football programs?

In this fictitious tale, we explore what such a set of rules would look like.

We ask:

* If these requirements would not work in an athletic setting, should we expect them to work in business? 
* Why are the governance provisions of Dodd-Frank legally required, rather than voluntarily adopted by individual companies?
* Why does Dodd-Frank place such emphasis on executive compensation and disclosure?  Will its compensation requirements reduce governance failures?

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.

There is a consistent pattern that emerges when a company suffers from a major governance failure: the stock price falls, the company faces lawsuits, and there is elevated turnover in both the executive suite and the boardroom.  

The impact on the careers of the former executives and directors of these companies is less clear.  Recent experience suggests that many CEOs and directors of failed companies are able to retain outside directorships–and even obtain new ones–following their forced departures.

1. Should this be a concern for shareholders?

2. What is the standard by which the culpability of an executive or director should be measured?  When are they “too tainted” by their experience to serve at other companies?

3. Is it plausible that officers and directors involved in an accounting or ethical problem can “learn valuable lessons” from the experience?

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

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