Follow up to our recent posting The Old Boys Network is Dead (Part 1)

In our most recent posting we discussed how changes in "who" gets to be a director are being discussed at a congressional level. We also discussed in another recent posting how the SEC was going to propose sweeping changes that will give shareholders greater access to the director nomination process. It seems now there is also a new bill being proposed by Democratic Senator Charles Schumer similar to the proposals that the SEC has now voted to amend this week.

It is hard to quantify the level of anger of shareholders and tax payers are feeling right now after having to "bail out" these organizations and their generous pay packages to executives. Predictably though when there is a public outcry Congressional Leaders (that sounds funny!!!) will see the opportunity for votes, now there is a rush on Capitol Hill to go beyond finger pointing and move to over regulate in our opinion.

Democratic Senator Charles Schumer introduced a bill on May 20th called the "Shareholder Bill of Rights" that among other things would require company directors to be subject to annual shareholder votes and to receive at least 50 percent of vote in uncontested elections to remain on the board. It would also instruct the SEC to issue rules that would grant shareholder access to the corporate proxy for nominations to the board of directors. To make a nomination, shareholders would have to have owned at least 1% of a public company's shares for at least two years. The bill would also require a separation of the Chairman and CEO duties and require shareholder approval for "golden parachutes" and hefty pay packages. Finally it would also require that corporate boards establish risk committees (yeah, another committee, just what we needed!!!). "It has become apparent that one of the central causes of the financial and economic crises we face today is the widespread failure of corporate governance," Schumer said in a letter to lawmakers.

We had three main concerns in our posting on Feb 26th 2009 and two of which seem to be embedded in this proposed bill. The federal government is going to try and regulate board leadership (impossible) and predictably will try to over regulate. The third concern is still a possibility depending on the outcome but probably less likely.

We agree that reform is needed and warranted as evidenced by SOME of the recent governance issues. SOME companies did not have a Board of Directors that was focused on the long term viability of their organizations. SOME companies and directors bet their businesses futures on massive leveraging and then over compensated the management teams (which was easy given the dual roles of Chairman and CEO) while leaving the shareholders with "profits" that ended up becoming "toxic" assets on their balance sheets. We want to make clear this is SOME companies and although these Directors should have serious consequences put on them to make all companies comply with regulations and new committees that don't really solve the root problem seems ludicrous.

Many of these Directors were the problem (some still are) and we believe that coming up with an objective way of nominating board members for strategic reasons and evaluating their performance on a YEARLY basis (yearly director evaluations is part of the amendments). This is critical to ensuring that they are providing value to the shareholders and the organization. This is what we do at ABA. However, we feel that simply having a shareholder vote replaces one subjective nomination process and analysis of board members performance with another. An example would be how would shareholders (primarily institutional investors) evaluate directors in order to make an informed vote or nomination? Are nominations still going to based on some personal relationship or resume for nominations? Would shareholders only evaluate the abilities of a director based on the stock price? Are we naive enough to think that one or two Directors could make a stock go up (or down) in a year? Does every company whose stock goes down have a bunch of bad directors? What type of board leadership and ultimately shareholder and organizational value does this generate for the long term? Are potential or current board members going to start having campaigns to get votes or nominations?

What has been proven again and again is when Congress gets involved in regulating business the decision is one that is going to be based on votes and polls not long term economic factors (or logic). We hope that they put aside for a second their political ambitions and careers and focus on how these decisions are going to have long term impacts to organizations (see Sarbanes Oxley and Enron). Focus on the root problem which is getting the right individuals on these boards for the right strategic reasons that can be quantified objectively and let's not replace one broken process or regulation with another. Either way the wheels of change are turning and the "old boys network" is definitely dead it is just a question of how it will die.

As we pointed out in the previous posting privately held companies should take note of what is going on in the public markets as the root problem is the same in most of those boards as well; the wrong people on the board or the right people for the wrong reasons can have a detrimental effect on your company.

Bob Arciniaga
Managing Partner/Founder
Advisory Board Architects