It is a pleasure for me to participate in this impressive annual conference and be a member of this stellar panel. It almost goes without saying that investor relations professionals are squarely in the center of the corporate governance debate. Responding to the governance concerns of investors, regulators, board members, and executives will become an increasingly important function of investor relations.
There is no doubt that good corporate governance is highly desirable for shareholders and stakeholders. Good governance is an important determinant of productivity, innovation, wealth, and a well-functioning society. Unfortunately, we have also observed the adverse consequences of bad governance. The fundamental (unanswered) question remains – “What does good or bad governance actually look like?” To paraphrase the famous Supreme Court decision – “Would you know it if you saw it?” I am very confident that we do not know the answer to this question, especially given the set of measurement tools that are imposed on firms.
There is little research that supports the validity of commonly used assessments for the quality of corporate governance. For example, various pundits chastise companies for having internal board members, the CEO also being the chairman of the board, a staggered board, and a host of similar structural attributes. While these criticisms may seem reasonable, research does not support the notion that these attributes are always undesirable. Simple “checkbox” assessments of corporate governance are as likely to be wrong as right.
The same remark applies to commercial firms that provide governance ratings and proxy voting recommendations to shareholders. These companies have done an excellent job highlighting the importance of corporate governance and forcing boards to think carefully about governance choices. However, there remain serious questions around the use of both of these services. For example, corporate governance ratings have been shown to have very little ability to predict future problems (restatements and shareholder litigation) or operating and stock price performance. One pointed response that I have received regarding this research is that “our ratings are not meant to predict future performance or returns” and that “our ratings help financial market participants to flag investment risk.” These are strange comments – if you can assess future investment risk, you will automatically produce better future performance for shareholders. If these ratings are not predictive, they are of little use to boards and investors for assessing corporate governance. Moreover, there is no reason for a company to change their governance in a way that produces an increase in the rating. These ratings may not be irrelevant, but the research to date has not proved their usefulness.
Aside from governance ratings, the more serious issue is whether the voting recommendations by proxy advisory firms create or destroy shareholder value. This is an extremely important issue because institutional shareholders have a fiduciary responsibility to vote their shares in a manner consistent with shareholder interests. The important question is whether “outsourcing” voting on board members, compensation programs, and mergers to proxy advisory firms maximizes shareholder value. This is an even more serious question since the amending of Regulation 452.
To my knowledge, there is no evidence on whether recommendations by proxy advisory firms for (say) new equity-based compensation plans are appropriate. One of the more controversial elements used in their recommendations concerns the Shareholder Value Transfer (SVT) computation and the comparison to a largely arbitrary threshold. It is clearly necessary for the board of directors to compute the wealth transfer from shareholders to executives produced by new equity-based plans. However, what is the correct threshold for determining whether the required grant is too big? Should this threshold be the average SVT for companies in the same industry that are in the highest quartile of total shareholder return (TSR)? Is there any evidence that this is the correct threshold for shareholder voting? It is easy to think of situations where this threshold is not appropriate for technology companies and turnarounds. This is a serious question with important implications for attracting and motivating employees. We are presently researching this topic and would welcome any insights or feedback from you on this project.
Finally, the perceived problems with executive compensation and corporate governance have led to many proposed regulations and legislative proposals (a veritable feeding frenzy at the SEC and in Congress). These proposals deal with topics such as restricting staggered boards, CEO duality, say-on-pay, compensation consultants, and risk management. However, the most important feature is proxy access and majority voting (with required resignation if sufficient positive votes are not obtained). Obviously, the government is an increasingly important player in corporate governance.
The interesting question is whether regulating corporate governance is good for shareholders. Looking at the stock market reaction to the various proposals reveals some fascinating results. There is a very strong negative market reaction for firms where there are many one percent stock holders or where there are many small coalitions of shareholders that exceed the one percent threshold (one percent is the current proposed threshold for allowing proxy access). Clearly, the proposed governance regulations harm shareholders of firms that are likely to be affected by new proxy access. There may be some governance regulations that increase shareholder value, but they are not the ones that seem likely to be approved in the near future.
The debate about corporate governance has a long history and will be an active discussion for years to come. It is my hope that we can move beyond blue ribbon panels and populist rhetoric about what really constitutes good or bad corporate governance. I believe that collaborative research between organizations like NIRI and universities is required in order to unravel this concept we call corporate governance. Research results (where context and nuances are important elements in the design) would provide the tools that investor relations professionals need to respond to governance concerns. We at the Stanford Rock Center and Corporate Governance Research Program welcome the opportunity to work with you on defining and measuring effective corporate governance.