[Senate Hearing 111-315]
[From the U.S. Government Publishing Office]
S. Hrg. 111-315
PROTECTING SHAREHOLDERS AND ENHANCING PUBLIC CONFIDENCE BY IMPROVING
CORPORATE GOVERNANCE
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
SECURITIES, INSURANCE, AND INVESTMENT
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
ON
EXAMINING THE IMPROVEMENT OF CORPORATE GOVERNANCE FOR THE PROTECTION OF
SHAREHOLDERS AND THE ENHANCEMENT OF PUBLIC CONFIDENCE
__________
JULY 29, 2009
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.access.gpo.gov /congress /senate/
senate05sh.html
----------
U.S. GOVERNMENT PRINTING OFFICE
55-479 PDF WASHINGTON : 2010
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York JIM BUNNING, Kentucky
EVAN BAYH, Indiana MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey MEL MARTINEZ, Florida
DANIEL K. AKAKA, Hawaii BOB CORKER, Tennessee
SHERROD BROWN, Ohio JIM DeMINT, South Carolina
JON TESTER, Montana DAVID VITTER, Louisiana
HERB KOHL, Wisconsin MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia KAY BAILEY HUTCHISON, Texas
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado
Edward Silverman, Staff Director
William D. Duhnke, Republican Staff Director
Dawn Ratliff, Chief Clerk
Devin Hartley, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on Securities, Insurance, and Investment
JACK REED, Rhode Island, Chairman
JIM BUNNING, Kentucky, Ranking Republican Member
TIM JOHNSON, South Dakota MEL MARTINEZ, Florida
CHARLES E. SCHUMER, New York ROBERT F. BENNETT, Utah
EVAN BAYH, Indiana MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey DAVID VITTER, Louisiana
DANIEL K. AKAKA, Hawaii MIKE JOHANNS, Nebraska
SHERROD BROWN, Ohio BOB CORKER, Tennessee
MARK R. WARNER, Virginia
MICHAEL F. BENNET, Colorado
CHRISTOPHER J. DODD, Connecticut
Kara M. Stein, Subcommittee Staff Director
William H. Henderson, Republican Subcommittee Staff Director
Dean V. Shahinian, Senior Counsel
Brian Filipowich, Legislative Assistant
Randy Fasnacht, GAO Detailee
Hester Peirce, Republican Counsel
William Henderson, Republican Legislative Assistant
(ii)
C O N T E N T S
----------
WEDNESDAY, JULY 29, 2009
Page
Opening statement of Chairman Reed............................... 1
Prepared statement........................................... 42
Opening statements, comments, or prepared statements of:
Senator Bunning.............................................. 2
Senator Schumer.............................................. 3
WITNESSES
Meredith B. Cross, Director, Division of Corporation Finance,
Securities and Exchange Commission............................. 6
Prepared statement........................................... 42
Responses to written questions of:
Senator Bunning.......................................... 230
John C. Coates IV, John F. Cogan, Jr., Professor of Law and
Economics, Harvard Law School.................................. 8
Prepared statement........................................... 45
Responses to written questions of:
Senator Bunning.......................................... 232
Senator Vitter........................................... 234
Ann Yerger, Executive Director, Council of Institutional
Investors...................................................... 9
Prepared statement........................................... 50
Responses to written questions of:
Senator Bunning.......................................... 235
Senator Vitter........................................... 239
John J. Castellani, President, Business Roundtable............... 11
Prepared statement........................................... 127
Responses to written questions of:
Senator Bunning.......................................... 240
J.W. Verret, Assistant Professor of Law, George Mason University
School of Law.................................................. 13
Prepared statement........................................... 224
Responses to written questions of:
Senator Bunning.......................................... 244
Senator Vitter........................................... 244
Richard C. Ferlauto, Director of Corporate Governance and Pension
Investment, American Federation of State, County, and Municipal
Employees...................................................... 15
Prepared statement........................................... 225
Responses to written questions of:
Senator Bunning.......................................... 245
(iii)
PROTECTING SHAREHOLDERS AND ENHANCING PUBLIC CONFIDENCE BY IMPROVING
CORPORATE GOVERNANCE
----------
WEDNESDAY, JULY 29, 2009
U.S. Senate,
Subcommittee on Securities, Insurance, and Investment,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee met at 2:35 p.m., in room SD-538, Dirksen
Senate Office Building, Senator Jack Reed (Chairman of the
Subcommittee) presiding.
OPENING STATEMENT OF CHAIRMAN JACK REED
Chairman Reed. Let me call the hearing to order and welcome
our witnesses. Thank you, ladies and gentlemen. We expect
momentarily that the Ranking Member will arrive, and I thank
Senator Corker and Senator Menendez for joining us.
Today's hearing will focus on corporate boardrooms and try
to help us better understand the misaligned incentives that
drove Wall Street executives to take harmful risks with the
life savings and retirement income of so many people. This
Subcommittee has held several hearings in recent months to
focus on gaps in our financial regulatory system, including the
largely unregulated markets for over-the-counter derivatives,
hedge funds, and other private investment pools.
We have also examined problems that resulted from
regulators simply failing to use the authority they had, such
as our hearing in March that uncovered defective risk
management systems at major financial institutions.
But although regulators play a critical role in policing
the markets, they will always struggle to keep up with evolving
and cutting-edge industries. Today's hearing will examine how
we can better empower shareholders to hold corporate boards
accountable for their actions and make sure that executive pay
and other incentives are used to help companies better focus on
long-term performance goals over day-to-day profits. In this
latter regard, this is a timely hearing based on the action
yesterday of the House Financial Services Committee.
Wall Street executives who pursued reckless products and
activities they did not understand brought our financial system
to this crisis. Many of the boards that were supposed to look
out for shareholders' interests failed at this most basic of
jobs. This hearing will help determine where the corporate
governance structure is strong, where it needs improvement, and
what role the Federal Government should play in this effort.
I will ask our witnesses what the financial crisis has
revealed about current laws and regulations surrounding
corporate governance, including executive compensation, board
composition, election of directors and other proxy rules, and
risk management. In particular, we will discuss proposals to
improve the quality of boards by increasing shareholder input
into board membership and requiring annual election of and
majority voting for each board member.
We will also discuss requiring ``say-on-pay,'' or
shareholder endorsements of executive compensation. We need to
find ways to help public companies align their compensation
practices with long-term shareholder value and for financial
institutions overall firm safety and soundness. We also need to
ensure that compensation committee members who play key roles
in setting executive pay are appropriately independent from the
firm managers that they are paying.
Other key proposals would require public companies to
create risk management activities on their boards and separate
the chair and CEO positions to ensure that the CEO is held
accountable by the board and an independent chair.
I hope today's hearing will allow us to examine these and
other proposals and take needed steps to promote corporate
responsiveness to the interests of shareholders, and I welcome
today's witnesses and look forward to the testimony.
Now let me recognize Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman. I am sorry I am
just a little late. Phone calls are a pain right now.
This is a very important topic for us, but a hard one to
deal with. While we may be able to make some reforms that will
promote good long-term performance and responsible behavior, we
will not, I say, be able to prevent bad decisions or failures.
After all, we cannot legislate good judgment or ethics. And we
already have the ultimate form of accountability through
bankruptcy.
In general, pay should promote good long-term performance,
and shareholders must share in the gain, not just executives
and traders. Boards must be more involved--I say that again:
Boards must be more involved and be an effective check on
management. Proxy access must benefit the majority of
stockholders and encourage long-term values. If we are not
careful, those changes could have the exact opposite effect by
empowering a minority of shareholders to strip the company of
value and encourage risky behavior in search of short-term
profits.
While we are right to be outraged at what has gone on in
the financial sector, we must be careful that efforts to rein
in Wall Street's behavior do not put handcuffs on other
businesses that have different needs and challenges. Corporate
law for the first 230-plus years of this country has been
handled pretty well at the State level, and if we are going to
change that, we should be sure of what we are doing. And I am
sure looking forward to hearing what our panel has to say.
Thank you.
Chairman Reed. Thank you very much, Senator Bunning.
Senator Corker, do you have any opening comments?
Senator Corker. As always, I prefer to listen to the
witnesses and ask questions, but thank you all for being here.
Chairman Reed. Thank you, Senator.
Senator Schumer has arrived, and I know he has taken a
leadership role on this issue of corporate governance with his
legislative proposals and his constant attention. In fact, it
was Senator Schumer's suggestion that we hold this hearing, so
I want to recognize him for any comments that he might have.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Well, thank you, Senator Reed, and let me
express my profound gratitude to you for holding this hearing
and to Ranking Member Bunning for being here as well on such an
important subject.
As you acknowledged, Mr. Chairman, corporate governance is
of great importance to me, and I introduced the Shareholder
Bill of Rights with Senator Cantwell earlier this year. The
bill was supported by 20 major pension funds, consumer groups,
labor unions, and just yesterday, the House Financial Services
Committee passed a ``say-on-pay'' bill similar to the ``say-on-
pay'' we have in the Shareholder Bill of Rights. So I am glad
to see Congress is moving forward in this process, and today's
hearing is a great opportunity to get a chance to explore these
issues in more detail.
In the last year-plus, we have talked a great deal about
the failures of regulation and Government oversight in the
financial system. But our dynamic economy and capital markets
also depend on internal oversight by vigilant boards of
directors who ensure that management is steering the ship in
the right direction.
Unfortunately, there are far too many cases recently where
boards of directors, not just regulators, were asleep at the
wheel, or even complicit in practices that caused great harm to
our economy and shook public confidence in our capital markets.
Executives who encouraged risk-taking that they did not
understand were not checked by their boards. Compensation
packages that rewarded short-term actions but not long-term
thinking were not undone by their boards.
Fundamentally, too many boards neglected their most
important job: prioritizing the long-time health of their firms
and their shareholders and carefully overseeing management. In
other words, there was widespread failure of corporate
governance that has proven disastrous not just for individual
businesses but for the economy as a whole.
And there are many in this room on both sides of the aisle
who say, you know, the Government cannot get involved in the
details of what a company does. And that is right. That is our
free market system. But the place that there is supposed to be
a check is in the board of directors, and when over the years
in too many companies--there are many companies that have good
boards and many companies that already have implemented many if
not all the reforms in our bill. But in too many companies, the
boards did not do the job.
And the damage. What if the board of AIG had checked some
of its actions? What is the board of Bear Stearns had checked
some of its actions? The taxpayers probably would have saved
hundreds of billions of dollars. So it affects all of us. It is
not just the internals of the company.
And so Senator Cantwell introduced our bill. It makes
corporate boards accountable to the shareholders whose
interests they are supposed to protect. The Shareholder Bill of
Rights will go a long way to making sure that these failures do
not happen again, and as everyone knows, there are six key
components in our bill. I am not going to read them. I am going
to save that in the interest of time.
Several elements of the bill have already been in place, as
I said, by many corporations, and that is important to
remember, because for many corporations, these are already best
practices. Well-run companies do not fear their shareholders
because they recognize that boards, management, and
shareholders share the same interests: long-term growth and
profitability. The greatest damage occurs not when boards are
too active, but when they are not active enough.
I think the Shareholder Bill of Rights will go a long way
to ensuring that companies are responsive to their
shareholders' interests. I thank you and congratulate you,
Chairman Reed, for putting together an excellent panel. I look
forward to the hearing, the testimony of the witnesses, and I
would ask that my entire statement be put in the record.
Chairman Reed. Without objection, all statements will be
put in the record.
Senator Corker, do you have a comment?
Senator Corker. Mr. Chairman, this is an unusual request. I
do not really know what those six elements are, and I think
since it sounds like----
Senator Schumer. Since you ask----
Senator Corker. This has not been a highly debated bill.
Since I sense this hearing has a lot to do with the fact that
this bill is being introduced, it might be good for all of us
to know what those six elements are?
Senator Schumer. OK. May I read them, Mr. Chairman? It will
take a minute.
Chairman Reed. Absolutely. This is----
Senator Schumer. Unusual.
Chairman Reed. Unusual. Usually, you do not need
encouragement.
[Laughter.]
Senator Corker. Let me say this. I want to, for the record,
note that I usually do not like to hear any opening comments,
but in this case, since----
Senator Schumer. Yes, well, thank you. And I was going to
say, similar to what Jack Reed said, this is the first time
that someone has asked Chuck Schumer to say more on a subject
than he has said. Here they are.
First, we require all public companies hold an advisory
shareholder vote on executive compensation and obtain
shareholder approval for golden parachutes.
Second, we instruct the SEC to issue rules allowing long-
term shareholders with significant stakes in the company to
have access to the company's proxy form if they want to
nominate directors to the board. If you are going to try to
keep the board honest, you ought to have access to proxies. Now
it is next to impossible for people to get.
Third, it requires boards of directors to receive a
majority of the vote in uncontested elections in order to
remain on the board. It makes no sense for board members to be
reelected if the majority of shareholders casting ballots vote
against them.
Fourth, it eliminates staggered boards which insulate board
members from the consequences of their decisions by requiring
all directors to face election annually.
Fifth, it requires public companies to split the jobs of
CEO and chairman of the board and requires the chairman to be
an independent director. That one has gotten the most pushback
from the corporate world. That surprised me, but that is the
facts.
And, sixth, and finally, requires public companies to
create a separate risk committee containing all independent
directors to assess the risks that the company is undertaking.
Thank you, Mr. Chairman. Thank you, Senator Corker.
Chairman Reed. Thank you both.
We have been joined by Senator Warner. I wonder if you have
any opening comments, Senator.
Senator Warner. I will--have I missed testimony already?
Chairman Reed. No, you have not.
Senator Warner. I am anxiously looking forward to the
testimony.
Chairman Reed. Thank you. Now let me introduce our
witnesses.
Our first is Ms. Meredith B. Cross, the Director of the
Division of Corporation Finance at the U.S. Securities and
Exchange Commission. Prior to joining the staff in June 2009,
Ms. Cross was a partner at Wilmer, Cutler, Pickering, Hale &
Dorr in Washington, DC, where she advised clients on corporate
and securities matters, was involved with the full range of
issues faced by public and private companies in capital raising
and financial reporting. Prior to joining Wilmer Hale, Ms.
Cross worked at the SEC from 1990 to 1998 in various
capacities, including chief counsel and deputy director of the
division she now leads.
Our next witness is Professor John C. Coates. Professor
Coates is the John F. Cogan, Jr. Professor of Law and Economics
at Harvard Law School. He joined the faculty in 1997 after
practicing at the New York law firm of Wachtell, Lipton, Rosen
& Katz where he was a partner specializing in mergers and
acquisitions, corporate and securities law, and the regulation
of financial institutions. He is a member of the Legal Advisory
Committee of the New York Stock Exchange, and he is the author
of a number of articles on corporate, securities, and financial
institution law and for 7 years coauthored the leading annual
survey of development and financial institution M&A.
Our next witness is Ms. Ann Yerger. She is the Executive
Director of the Council of Institutional Investors, an
organization of public, corporate, and Taft-Hartley pension
funds. Ms. Yerger joined the council in early 1996 as the
Director of the Council's Research Service before being named
Executive Director in January 2005. Her prior experiences
include work at the Investor Responsibility Research Center and
Wachovia Bank.
Our next witness is Mr. John J. Castellani. Mr. Castellani
is the President of the Business Roundtable, an association of
chief executive officers of U.S. companies. Mr. Castellani
joined the Business Roundtable in May 2001 and had led the
group's efforts on public policy issues ranging from trade
expansion to civil justice reform to fiscal policy. Prior to
becoming President of the Business Roundtable, Mr. Castellani
was Executive Vice President of Tenneco, Incorporated.
Our next witness is Professor J.W. Verret. Professor Verret
is an Assistant Professor of Law at George Mason University
School of Law. He has written extensively on corporate law
topics, including a recent paper cowritten with Chief Justice
Myron T. Steele of the Delaware Supreme Court. Prior to joining
the faculty at George Mason Law School, Professor Verret was an
associate in the SEC Enforcement Defense Practice Group at
Skadden Arps in Washington, DC, and also served as a law clerk
for Vice Chancellor John W. Noble of the Delaware Court of
Chancery. This forum is critical for disputes between
shareholders and directors of Delaware corporations--which, by
the way represents about 70 percent of the publicly traded
corporations.
Our final witness is Mr. Richard C. Ferlauto. Mr. Ferlauto
is Director of Corporate Governance and Pension Investment at
the American Federation of State, County, and Municipal
Employees, AFSCME, where he is responsible for representing
public employee interest and public retirement and benefit
systems. Mr. Ferlauto is also the founder and chairman of
ShareOwners.org, a nonprofit, nonpartisan shareholder education
organization. Prior to joining AFSCME, Mr. Ferlauto was the
Managing Director of Proxy Voter Services/ISS, which provides
proxy advisory services to Taft-Hartley and publicly funded
plan sponsors.
I appreciate all of your appearance here today and let me
recognize Ms. Cross.
STATEMENT OF MEREDITH B. CROSS, DIRECTOR, DIVISION OF
CORPORATION FINANCE, SECURITIES AND EXCHANGE COMMISSION
Ms. Cross. Good afternoon, Chairman Reed, Ranking Member
Bunning, and Members of the Subcommittee. My name is Meredith
Cross, and I am Director of the Division of Corporation Finance
at the U.S. Securities and Exchange Commission. As you noted, I
just rejoined the SEC staff in June of this year after more
than 10 years in private practice here in Washington. I worked
at the SEC for most of the 1990s, and I am delighted to be back
at the agency at this critical time in the regulation of our
financial markets. I am pleased to testify on behalf of the
Commission today on the topics of corporate governance and the
agency's ongoing efforts to assure that investors have the
information they need to make informed voting and investment
decisions.
Good corporate governance is essential to investor
confidence in the markets, and it cannot exist without
transparency--that is, timely and complete disclosure of
material information. In responding to the market crisis and
erosion of investor confidence, the Commission has identified
and taken steps over the past months in a number of significant
areas where the Commission believes enhanced disclosure
standards and other rule changes may further address the
concerns of the investing public.
Two months ago, the Commission voted to approve proposals
designed to help shareholders more effectively exercise their
State law right to nominate directors. Under the proposals,
shareholders who otherwise have the right to nominate directors
at a shareholder meeting would, subject to certain conditions,
be able to include a limited number of nominees in the company
proxy materials that are sent to all shareholders whose votes
are being solicited. Shareholders also would have an expanded
ability to include in company proxy materials shareholder
proposals addressing this important topic. In addition, the
Commission recently proposed amendments to its proxy rules to
enhance the disclosure that is provided to shareholders in
company proxy statements, a key document in shareholders'
voting decisions on the election of directors.
Under the proposals, shareholders would receive expanded
information about the qualifications of directors and director
candidates, the board's leadership structure and role in risk
management, and potential conflicts of interest of compensation
consultants, in addition to enhanced disclosure concerning the
company's compensation policies and whether they create
incentives for employees to act in a way that creates risks
that are not aligned with the company's objectives. The
proposal also would improve the reporting of annual stock and
option awards to company executives and directors and would
require quicker reporting of shareholder vote results.
The Commission also recently proposed amendments to the
proxy rules to clarify the requirements consistent with the
Emergency Economic Stabilization Act of 2009 for a ``say-on-
pay'' vote at public companies that have received and not
repaid financial assistance under the TARP and approved changes
to the New York Stock Exchange rules to prohibit brokers from
voting shares held in street name in director elections unless
they have received specific voting instructions from their
customers.
Finally, the Commission has asked the staff to undertake
this year a comprehensive review of other potential
improvements to the proxy voting system and shareholder
communications rules. The Commission looks forward to hearing
from the public on the outstanding proposals and to carefully
considering all views in moving forward over the coming months.
Thank you again for inviting me to appear before you today
and for the Subcommittee's support of the agency in its efforts
at this critical time for our Nation's investors. The
Commission will remain vigilant in its efforts to support
strong corporate governance and disclosure practices and also
stands ready to lend whatever assistance it can to the work
that is going on outside the agency on these important topics.
I would be happy to answer any questions you may have.
Chairman Reed. Thank you very much, Ms. Cross.
Professor Coates.
STATEMENT OF JOHN C. COATES IV, JOHN F. COGAN, JR., PROFESSOR
OF LAW AND ECONOMICS, HARVARD LAW SCHOOL
Mr. Coates. Thank you, Senator Reed, thank you, Ranking
Member Bunning, and the rest of the Members of the Committee
who are. I very much appreciate the opportunity to talk about
corporate governance.
Good corporate governance is an essential foundation to
economic growth, and so this could not be a more important time
for the Congress to be focusing on it.
There are a large number of reforms--six in Senator
Schumer's bill alone, and there are many others--that we could
talk about. I am going to talk about a few. I am happy to talk
about others that you may have questions about or want to
explore. But before I talk about specifics, let me make two
general remarks that I think should be kept in mind in thinking
about any particular reform.
First, and maybe a little controversially, I think it is
fair to say that the academic perspective on corporate
governance would view financial firms differently than other
kinds of corporations, and not in the straightforward way that
you might think; that is to say, shareholders of financial
firms want financial firms to take risk and want them to take
more risk than may be appropriate from the perspective of the
taxpayer. That is because many of the large financial
institutions are, as we have learned, too big, too complex to
fail, so that from the shareholders' perspective, if things go
well with the risks that the companies take, they are on the
upside; and if things go badly, then in the end it is the
taxpayer who helps defray the costs to the shareholders.
As a result of that, I do not think that it would be a good
idea to give shareholders considerably more power in the
governance of large financial institutions. I think, in fact,
if anything, financial regulators should be given more
authority to check the power that shareholders have, at least
on particular issues--compensation being one. The compensation
structures and incentives that shareholders, even if the boards
are doing exactly the right thing for shareholder, that
shareholders want of large banks are not the ones that are
going to be the most safe and most sound from the perspective
of the American public. So that is the first general remark.
Second is across the board on this, I think it is fair to
say that academic and scientific research more generally is
quite weak. It is evolving. There is almost no nontrivial issue
in corporate governance about which there is not fierce
academic as well as political argument. That cautions against
passing rules that are fixed, mandatory, and are hard to change
over time. Instead, it cautions for giving shareholders the
ability to adopt rules for their own companies, facilitating
collective action by them--and that is an important role, I
think, that regulation can play. Shareholders of public
companies are dispersed, cannot easily act on their own, and
often face entrenched boards who are unwilling to make changes
when they are, in fact, the best thing for the companies.
The caution about the weakness of the scientific evidence
is also not a reason to do nothing because what I just said is
one thing that there is general consensus on. Disperse
shareholders have a hard time acting for themselves as the
number of shareholders increase. And the other general
consensus, I would say, across the board is that corporate
governance in the United States in the last 10 to 20 years has
not performed terribly well at a large number of companies. And
so there is need for change, and there is need for carefully
considered moderate reforms of a kind that can be revised over
time as learning on these subjects grows.
So on the specifics, let me say quickly, I think the
evidence that we do have is that ``say-on-pay'' is a good idea,
and I am happy to expound on that beyond that bottom-line
conclusion.
I would say for large companies, splitting CEOs from
chairmen has some evidence behind it that that is a good thing.
Smaller companies, I am not so sure the evidence is there. But
as long as the SEC is given appropriate authority to tailor any
legislation in this area, I think that would be a good thing to
pursue.
I would say that staggered boards, the evidence, if
anything, runs against eliminating them. They are an important
option between, on the one hand, a fully contestable corporate
governance structure where every director is up for election
every year, and a governance structure where essentially the
insiders have complete control, as in the case of Google, which
is a reasonably successful company. In between, staggered
boards have proven to be a type of governance structure that
investors and new IPOs have been willing to put their money
behind, and to ban them across the board I don't think is
supported by the evidence at the moment.
On shareholder access, just to wrap up, frankly there is no
evidence, and I think there is--that is a reason to proceed,
but to proceed cautiously, to proceed through the SEC, and here
I think the SEC already has adequate authority to pursue this
topic. But the one thing Congress probably could clarify is
exactly what their authority is in this area, and I think that
would be a good thing.
With that, thank you.
Chairman Reed. Thank you very much, Professor Coates.
Ms. Yerger.
STATEMENT OF ANN YERGER, EXECUTIVE DIRECTOR, COUNCIL OF
INSTITUTIONAL INVESTORS
Ms. Yerger. Good afternoon. Thank you very much for the
opportunity to share the council's views on the very important
issues under consideration today.
By way of introduction, council members are responsible for
safeguarding assets used to fund the retirement of millions of
individuals throughout the United States. They are capitalists,
responsible for an aggregate portfolio of somewhere north of $3
trillion in assets. They have a very significant commitment to
the domestic markets, on average investing about 60 percent of
their portfolios in stocks and bonds of U.S. public companies.
And they are long-term, patient investors due to their long
investment horizons and their very heavy commitment to passive
investment strategies.
Council members have been very deeply impacted by the
financial crisis, and they have a vested interest in ensuring
that the gaps and shortcomings exposed by this crisis are
repaired. Clearly, a review and restructuring of the U.S.
financial regulatory model are necessary steps toward restoring
investor confidence and protecting against a repeat of these
failures. But regulatory reform alone is insufficient.
Corporate governance failures also contributed to this crisis,
and as a result, governance reforms are an essential piece of
the reform puzzle.
Failures of board oversight, of enterprise risk, and
executive pay were clear contributors to this crisis. In
particular, far too many boards structured and approved
executive pay programs that motivated excessive risk-taking and
paid huge rewards, often with little or no downside risk, for
short-term results. Current corporate governance rules also
failed by denying owners of U.S. companies the most basic
rights to hold directors accountable. The council believes
governance reforms in four areas are essential, and, Senator
Schumer, they will be familiar to you.
First, Congress should mandate majority voting for
directors of all U.S. public companies. It is a national
disgrace that under most State laws the default standard for
uncontested director elections is a plurality vote, which means
that a director is elected even if a majority of the shares are
withheld from the nominee. The corporate law community has
taken baby steps to accommodate majority voting, and some
companies have volunteered to adopt majority voting, but
sometimes only when pressured by shareowners.
But while many of the largest U.S. companies have adopted
majority voting, plurality voting still dominates at small and
midsized U.S. companies. This is a fundamental flaw in our
governance model. Given the failure by the States, particularly
Delaware, to lead this reform, the council believes that the
U.S. Congress must legislate this important and most basic
shareowner right.
Second, Congress should affirm the SEC's authority to
promulgate rules allowing owners to place their director
nominees on management's proxy card. The council believes a
modest proxy access mechanism would substantially contribute to
the health of our U.S. governance model by making boards more
responsive to shareowners, more thoughtful about whom they
nominate, and more vigilant about their oversight
responsibilities.
The council commends the SEC for its leadership on this
important reform, but, unfortunately, the SEC may face
unnecessary, costly, and time-consuming litigation in response
to any approved access mechanism. To ensure that owners of U.S.
companies face no needless delays over the effective date of
this critical reform, the council recommends congressional
affirmation of the SEC's authority.
Third, Congress should pass legislation mandating annual
advisory votes on executive pay, explore strengthening clawback
standards, and support the SEC's efforts to enhance executive
pay disclosures.
Council members have a vested interest in ensuring that
U.S. companies attract, retain, and motivate the highest-
performing employees and executives. But as highlighted by this
crisis, they are harmed when poorly structured pay programs
reward go-for-broke, short-term performance that ultimately
harms the company's long term.
The council believes executive pay issues are best
addressed by: first, requiring companies to provide full
disclosure of key elements of pay; second, ensuring that
directors can be held accountable for their pay decisions
through majority voting and access mechanisms; third, by giving
shareowners oversight of executive pay via annual nonbinding
votes; and, fourth, by requiring disgorgement of ill-gotten
gains.
One technical suggestion. We recommend that legislation
mandating annual advisory votes stipulate that these are a
nonroutine matter for purposes of New York Stock Exchange Rule
452.
Fourth, Congress should mandate that all corporate boards
be chaired by an independent director. The council believes
separating these positions appropriately reflects differences
in the roles, provides a better balance of power between the
CEO and the board, and facilitates strong, independent board
leadership and functioning.
In closing, empirical evidence from around the globe
supports these reforms. The experiences in other countries and,
where applicable, here in the United States are powerful
evidence that these reforms are not harmful to the markets and,
of note, these measures do not reward short-termism. On the
contrary, they are tools to enable owners to think and act for
the long term.
Thank you for your consideration of these important issues,
and I look forward to answering any questions.
Chairman Reed. Thank you very much, Ms. Yerger.
Mr. Castellani.
STATEMENT OF JOHN J. CASTELLANI, PRESIDENT, BUSINESS ROUNDTABLE
Mr. Castellani. Thank you. Good afternoon, Mr. Chairman,
Ranking Member Bunning, Members of the Committee. I am John
Castellani, President of the Business Roundtable.
The Business Roundtable has long been at the forefront of
efforts to improve corporate governance. We have, in fact, been
issuing best practice statements in this area for more than
three decades. All of those best practice statements are driven
by one principle: To further U.S. companies' ability to create
jobs, product service benefits, and shareholder value that
improve the well-being of all Americans.
At the outset, I must respectfully take issue with the
premise that the most significant cause of the current
financial crisis was problems in corporate governance. The
financial crisis likely stemmed from a variety of complex
factors, including failures of the regulatory system, over-
leveraged financial markets, a real estate bubble, as well as
failures in risk management.
The recently established Financial Crisis Inquiry
Commission is just starting its work, and any attempt to make
policy in response to the purported causes would seem
premature. In fact, to do so could well exacerbate factors that
may have contributed to the crisis, such as the emphasis on
short-term gains at the expense of long-term sustainable
growth.
Moreover, the problems giving rise to the financial crisis
occurred at a specific group of companies, financial
institutions. Responding by enacting a one-size-fits-all
corporate governance regime applicable to all 12,000 publicly
traded companies really does not make much sense. This approach
fails to consider a number of factors that I would like to
spend the remainder of my time this afternoon discussing.
First, there has been sweeping transformation of corporate
governance practices in the past 6 years, many of which have
been proactively adopted by companies. For example, the average
board independence of S&P 1500 companies increased from 69
percent in 2003 to 78 percent in 2008. That same group of
companies that have a separate chairman of the board increased
from 30 percent in 2003 to 46 percent in 2008. Many companies
have appointed an independent lead or presiding director who,
among other things, presides over executive sessions of the
independent directors. Companies have adopted majority voting
standards for the election of directors. In fact, more than 70
percent of the S&P 500 companies have done so. And many
companies have moved to the annual election of directors.
Second, applying a single one-size-fits-all approach to
corporate governance regardless of a company's size,
shareholder base, and other circumstances simply will not work.
While there is a multitude of guidance about best practices in
corporate governance, each company must periodically assess the
practices that will best enable it to operate most effectively
to create long-term shareholder value.
In this regard, we share the concerns recently expressed by
New Jersey Investment Council in the letter to SEC Chairman
Schapiro, that it is, quote, ``troubled by the proliferation of
rigid, prescriptive responses which are costly, time consuming,
unresponsive to individual fact settings surrounding specific
companies and industries, and which may correlate only randomly
with the creation of shareholder value.''
Third, for more than 200 years, State corporate law has
been the bedrock upon which the modern business corporation has
been created and has thrived. It remains the most appropriate
and effective source of corporate governance. In large part,
this stems from the flexibility provided by its enabling nature
and by its responsiveness in adjusting to current developments.
The amendments to Delaware and other States' laws over the past
several years have facilitated majority voting and director
elections, and the very recent amendments in Delaware law to
facilitate proxy access and proxy reimbursement bylaws are
examples of this responsiveness and flexibility.
Fourth, to the extent that shareholders desire change in a
particular company's corporate governance, many avenues are
available to them to make their views known and for companies
to respond. For example, shareholders may seek to have their
proposals included in company proxy statements. In recent
years, many companies have responded to these proposals by
adopting significant corporate governance changes, including
majority voting for directors, special meetings called by
shareholders, and the elimination of super-majority voting
requirements. Recently, some companies have implemented an
advisory vote on compensation, so-called ``say-on-pay,'' in
response to shareholder proposals. Shareholders often engage in
withhold campaigns against particular directors. And further,
shareholders can engage in proxy contests to elect their
director nominees to a company's board.
Finally, the SEC has an important role in seeing that
shareholders receive the disclosures that they need to make
informed decisions. In this regard, the SEC has issued a number
of corporate governance-related proposals that are aimed at
improving disclosure about director experience, board
leadership structure, oversight of risk management, executive
compensation, and potential conflicts of interest with
compensation consultants. The Business Roundtable generally
supports those.
Another more controversial SEC proposal seeks to amend the
proxy rules to permit shareholders to nominate directors in a
company's proxy materials. We have serious concerns with this
proposal, and we will share those concerns with the SEC in our
comments. But briefly, we believe that the adoption of this
proposal could promote short-termism, deter qualified directors
from serving on corporate boards, and lead to the election of
special interest directors, increase the influence of the proxy
advisory services, and highlight voting integrity problems in
the system.
In closing, let me emphasize the Roundtable's commitment to
effective governance practices and enabling U.S. companies to
compete globally, create jobs, and generate economic growth.
However, we must be careful that in a zeal to address our
current financial crisis, we do not adopt a one-size-fits-all
approach that can undermine the stability of boards of
directors and place companies under even greater pressure for
short-term performance. We must be cautious that we don't
jeopardize the engine of American wealth and prosperity.
Thank you.
Chairman Reed. Thank you very much, Mr. Castellani.
Professor Verret, please.
STATEMENT OF J.W. VERRET, ASSISTANT PROFESSOR OF LAW, GEORGE
MASON UNIVERSITY SCHOOL OF LAW
Mr. Verret. Chairman Reed, Ranking Member Bunning, and
distinguished Members of the Committee, I appreciate the
opportunity to testify in this forum today. My name is J.W.
Verret. I teach corporate law at George Mason Law School. I am
a Senior Scholar with the Mercatus Center Financial Markets
Working Group, and I also run the Corporate federalism
Initiative, a network of scholars dedicated to studying the
intersection of State and Federal authority in corporate
governance.
I will begin by addressing proxy access and executive
compensation rules under consideration, neither of which
address the current financial crisis and both of which may
result in significant unintended consequences. Then I will
close with a list of factors that did contribute to the present
financial crisis.
I am concerned that some of the corporate governance
proposals recently advanced impede shareholder voice in
corporate elections. This is because they leave no room for
investors to design corporate governance structures appropriate
for their particular circumstances and particular companies.
Rather than expanding shareholder choice, the proxy reform and
``say-on-pay'' proposals before this committee actually stand
in the way of shareholder choice. Most importantly, they do not
permit a majority of shareholders to reject the Federal
approach.
The Director of the United Brotherhood of Carpenters said
it best. Quote, ``We think less is more. Fewer votes and less
often would allow us to put more resources toward intelligent
analysis.'' The Brotherhood of Carpenters opposes the current
proposal out of concern about compliance costs. The proposals
at issue today ignore their concerns, as well as concerns of
many other investors.
Consider why one might limit shareholders from considering
alternative means of shareholder access. It can only be because
a majority of shareholders at many companies might reject the
Federal approach if given the opportunity. Not all shareholders
share the same goals. Public pension funds run by State elected
officials and union pension funds are among the most vocal
proponents of the proposals before this committee. There are
many examples where they used their power, their existing
shareholder power, toward their own special interests. Main
Street investors deserve the right to determine whether they
want the politics of unions and State pension funds to take
place in their 401(k)s.
The current proposals also envision more disclosure about
compensation consultants. Such a discussion would be incomplete
without mentioning conflicts faced by proxy advisory firms like
RiskMetrics, an issue the current proposals have failed to
address.
In addition, I will note that there is no evidence that
executive compensation played a role in the current crisis. If
executive compensation were to blame for the present crisis, we
would see significant difference between compensation policies
at those companies that recently returned their TARP money and
those needing additional capital. We do not.
Many of the current proposals also seek to undermine and
take legislative credit for efforts currently underway at the
State level and in negotiations between investors and boards.
This is true on proxy access, the subject of recent rule making
at the State level, and it is true for Federal proposals on
staggered boards, majority voting, and independent chairmen.
We have run this experiment before. The Sarbanes-Oxley Act
passed in 2002 was an unprecedented shift in corporate
governance, designed to prevent poor management practices.
Between 2002, when Sarbanes-Oxley was passed, and 2008, the
managerial decisions that led to the current crisis were in
full swing. I won't argue that Sarbanes-Oxley caused the
crisis, but this does suggest that corporate governance reform
at the Federal level does a poor job of preventing crisis.
And yet the financial crisis of 2008 must have a cause. I
commend this Committee's determination to undercover it, but
challenge whether corporate governance is, in fact, the
culprit. Let me suggest six alternative contributing factors
for this Committee to investigate.
One, the moral hazard problems created by the prospect of
Government bailout.
Two, the market distortions caused by subsidization of the
housing market through Fannie Mae, Freddie Mac, and Federal tax
policy.
Three, regulatory failure by the banking regulators and the
SEC in setting appropriate risk-based capital reserve
requirements for investment in commercial banks.
Four, short-term thinking on Wall Street, fed by
institutional investor fixation on firms making and meeting
quarterly earnings predictions.
Five, a failure of credit-rating agencies to provide
meaningful analysis caused by an oligopoly in the credit-rating
market supported by regulation.
Six, excessive write-downs in asset values under mark-to-
market accounting, demanded by accounting firms who refuse to
sign off on balance sheets out of concern about exposure to
excessive litigation risk.
Corporate governance is the foundation of American capital
markets. Shifting that foundation requires deliberation and a
respect for the roles of States in corporate governance.
Eroding that foundation risks devastating effects for capital
markets.
Thank you for the opportunity to testify and I look forward
to answering your questions.
Chairman Reed. Thank you very much, Professor.
Mr. Ferlauto, please.
STATEMENT OF RICHARD C. FERLAUTO, DIRECTOR OF
CORPORATE GOVERNANCE AND PENSION INVESTMENT,
AMERICAN FEDERATION OF STATE, COUNTY, AND MUNICIPAL EMPLOYEES
Mr. Ferlauto. Good afternoon, Chairman Reed and Members of
the Committee. My name is Rich Ferlauto. I am Director of
Corporate Governance and Pension Investment for AFSCME, the
public employee union.
Our union has a long-term abiding interest in the health of
the capital markets. Our 1.6 million members are invested
through public pension systems that have assets over $1
trillion. They depend on those assets for long-term retirement
security. Those public pension systems have got time horizons
of 20 to 30 years in which they need to pay out our member
benefits so that we are a long-time, long-term investor with
those types of time horizons.
I might also mention that AFSCME and the AFSCME Pension
Fund early on sued AIG over proxy access rights because we
understood that the board had failed to do the type of risk
disclosure that we felt was necessary and part of the
responsibility of directors.
I am also Chairman of Shareowners.org, a new nonprofit,
nonpartisan social networking organization designed to give
voice to retail shareholders who rarely have opportunities to
communicate with regulators, policy makers, and companies in
which they are invested.
I am here today to urge your focus on corporate governance.
We believe that corporate governance reform is essential to
good performing capital markets, and, in fact, with greater
corporate governance and shareholder rights, we could have
avoided some of the $11 trillion in asset loss that was faced
and felt dearly by our members and certainly the U.S.
households.
According to a recent public opinion survey by the Opinion
Research Corporation conducted for Shareowners, investors want
to see Congress take strong action to fix financial markets and
to clean up Wall Street. Such action, we believe, is essential
in order for you to rebuild confidence in the markets. Capital
markets will not work without investors. Investors will not
come back if they don't have confidence that the markets are
running appropriately.
Support for such action is strong across all age, income,
and educational and political affiliations. Thirty-four percent
of the investors that we surveyed used the term ``angry'' to
describe their views. The number one reason for the loss of
investor confidence in the market, we found, were ``overpaid
CEOs and/or unresponsive management and boards'' at 81 percent.
Six out of ten investors said that strong Federal action would
help restore their confidence in the fairness of the markets.
When we queried them about policy preferences, the survey
found that four out of five American investors agreed that
shareholders should be permitted to be actively involved in CEO
pay. Eighty-two percent agreed that shareholders should have
the ability to nominate and elect directors. And 87 percent of
investors who lose their retirement savings to fraud and abuse
should have the right to go to court to reclaim that money.
Fully consistent with these findings, we think that the
Committee should focus on fixing corporate governance. The core
to fixing corporate governance is to focus on the directors and
the responsibility between asset owners and their agents,
directors on corporate boards. The most critical change to do
that is to create a proxy access right so that shareholders,
particularly long-term shareholders who own patient capital in
the markets, so that they may cost effectively nominate
candidates for election to boards.
We are very encouraged that the SEC is in the process of
rule making on this issue but also believe that this is such an
important right that it should not become a political football
for future commissions. There needs to be long-term consistency
in securities laws and the Exchange Act is the appropriate
place to clearly codify the authority that the Commission has
to require disclosure of nominees running for board seats.
Proxy access is fundamental to free and fair election for
directors.
Second, shareholders should have a right to ``say-on-pay,''
a vote on the appropriateness of CEO compensation. We are
excited that we saw the vote in the House the other day, expect
to see a full vote this week, and as Ann Yerger from CII said,
we think it is absolutely essential that broker votes not be
included in the total so that a change to 452, excluding broker
votes on ``say-on-pay,'' would be a tremendous enhancement to
see on the Senate side.
I could make other comments, but let me wrap up by saying
we thank you, Mr. Chairman, for the opportunity to testify
today. Rebuilding investor confidence in the market depends on
thoughtful policymaking that expands investor rights and
authorizes the SEC to strengthen its advocacy role on behalf of
all Americans and their financial security.
I would be happy to answer any questions.
Chairman Reed. Thank you very much, Mr. Ferlauto.
Let us do a 6-minute initial round with the intention of
doing a second round so we can quickly get everyone to ask some
questions. We are extremely fortunate your testimony
collectively and individually has, I think, advanced this
argument and debate significantly.
Ms. Cross, one of the issues here that has been alluded to
by Professor Verret and others is the interaction between the
SEC and States, primarily Delaware, since they have 70 percent
of the public corporations. Can you comment upon this? In fact,
I think I noted in your proposed rules that they are subject to
the State corporate law, is that correct?
Ms. Cross. That is correct. Under the access proposal, you
would have a right of access to include nominees in an SEC
proxy--SEC-filed proxy only if you have a State law right to
nominate directors. So we start with the State law and then we
enable shareholders to exercise their State law rights through
the Federal proxy rules.
Chairman Reed. That raises the issue, really, of since the
proxy rules are Federal rules and not required by any States, I
don't think, I think this is a principal sort of issue between
whether or not there should be the ability of the SEC to
require these rules even if the State doesn't. Is that
something that you can't do now under present law or you choose
not to do?
Ms. Cross. That is a good question. Under State law now,
recent changes in Delaware include an ability for shareholders
to decide to vote to require the proxy access. We have
authority under our current rules, under the 34 Act, to also
require companies to include nominees in their proxy statement
and we believe these do coexist. The way we have done our
proposal assures that shareholders would have immediate access
to the proxy to nominate their holders if they satisfy our
requirements. They still could vote under State law to have--to
relax the standard so that more shareholders can do so.
Chairman Reed. Professor Verret, I think you are interested
in this topic. Your comments?
Mr. Verret. Mr. Chairman, I would only offer that the SEC's
proposal does include references to State law, but
specifically, the SEC's proposal says, sure, you can adopt a
bylaw that would describe how proxy access will work only if it
complies with the SEC's mandate. So it is very clear on that.
It runs roughshod, I think, over State corporation law
determining election rights, and so I think it expressly--you
might find references in there to State law, but the references
are intended to make clear that the SEC determines how proxy
access is going to work and if there is any--you can certainly
make up your own rules, only if they comply completely with the
SEC's rules on this essentially State corporate law matter.
Chairman Reed. Well, there are State corporate laws, but I
think you recognize that the proxy process is a result
primarily of Federal laws.
Mr. Verret. Well, the proxy process, sure, and the proxy
process was intended mostly about issues of disclosure. And I
would offer a quote from Justice Powell in CPS v. Dynamics. You
don't have to listen to me. Take Justice Powell's word for it.
No principle of corporate law is more firmly established than a
State's authority to regulate domestic corporations, including
the voting rights of shareholders. So Justice Powell, at least,
is with me on that one.
Chairman Reed. Do you agree with all of his opinions?
Mr. Verret. Well, no. No. I wouldn't say that.
[Laughter.]
Mr. Verret. But I like that one.
Chairman Reed. Let me shift to Professor Coates and Mr.
Castellani. You have described--in fact, you might comment on
this issue, too, Professor Coates, and then I have another
question.
Mr. Coates. I think it is, as I said in my opening remarks,
I think that if Congress were not to act, the SEC were to adopt
proxy access, it is almost certainly the case that someone will
challenge their authority to do so precisely along the lines
that Professor Verret has suggested. I think that challenge
will lose because I think the proposal is about communication.
It is allowing shareholders to exercise rights that they
clearly do have under State law.
The SEC's proposal would allow, contrary to what was
suggested earlier, any State to change its law and make it
clear that shareholders would not have the right to nominate
directors in this fashion and then the SEC's rules would not
override that State law decision. So the proposal, at least the
way I read it and the way I believe that a court would read it,
would not, in fact, conflict with State law on this issue.
Chairman Reed. Let me follow up on one of the comments you
made in your statement, and that is that we assume, I think,
that--at least there is a general assumption that shareholder
participation the way we describe would enhance the performance
of the company. But you suggest in certain situations,
financial institutions, for example, that it could have
perverse effects.
It seems to me that there are three or four different
decisions here. You can pay dividends. You can pay the
executives instead of paying dividends. Or you can reinvest and
increase shareholder value, et cetera. The shareholders, I
think, would be interested in dividends and maybe also, second,
long-term value, but less interested in compensation for
executives. But that is just a sort of prelude to the question
of what are the--what specific disincentives do you see if
shareholders can vote like this?
Mr. Coates. I mean, there has been a longstanding economic
theory about which there is a fair amount of evidence that
suggests that in a company's capital structure, there are
conflicts between the shareholders who are entitled to all
upside beyond the fixed payments that creditors are entitled to
and the creditors. The U.S. Government, because it insures the
deposits of all the banks that it insures, which is most of
them, is fundamentally a creditor of the large banking
institutions, and so there is, in fact, going to be on many
occasions a conflict of interest between shareholder interests
and the interest of the taxpayer with respect to insured
depository institutions. That is the fundamental conflict.
And to the extent that the proposals go toward increasing
shareholder power, that simply makes the bank regulators' jobs
in restraining risk taking by those banks at the behest of
shareholders and boards who are seeking to maximize share
value, even if it is long-term share value, that much harder.
So any effort in this area, I submit, should be accompanied by
clear authority for the banking regulators to at least moderate
the way these things play out for banking institutions.
Chairman Reed. Thank you. My time has expired.
Senator Bunning. And we will do a second round.
Senator Bunning. Thank you, Mr. Chairman.
Professor Verret, if we are going to make proxy access
easier for shareholders, what restrictions would you recommend
to make sure that the SS benefit a majority of shareholders and
the long-term value of the company and does not just benefit
small groups of investors and lead to short-term profits?
Mr. Verret. Well, Senator Bunning, I would offer that the
best person to make--the best group to make that assessment is
the shareholders themselves. And so I would leave it to
shareholders to determine how proxy access should work, how it
should operate.
And so for that reason, I think the innovations at the
level of Delaware and in the Model Business Code, which forms
the basis for 20 to 30 other corporate law codes of other
States, are on the right track. And I think also Commissioner
Paredes has offered a proposal to the SEC to help buttress this
development, to permit access for shareholder election bylaws
to the corporate ballot.
So in other words, instead of saying this is how the
elections should work, we say shareholders can put forward a
bylaw that should say how the election should work. All the
shareholders should determine how that election should work. In
many ways, it is similar to the Constitutional Convention.
Rather than choosing--the people got to choose the mechanism
by----
Senator Bunning. You are not suggesting we go back to a
Constitutional Convention----
Mr. Verret. No, no, but----
[Laughter.]
Senator Bunning. Not now.
Mr. Verret. But in effect, a ratification of a shareholder
election bylaw is kind of like a Constitutional Convention for
shareholders. I think that is an apt analogy.
Senator Bunning. Professor Coates, in your written
testimony--written--you raised an interesting idea. Rather than
forcing a structure on all companies, you suggested an opt out
vote by shareholders every few years for some governance
proposals. That idea could be applied to proxy access and
advisory vote procedures as well, instead of Government
deciding what the rules will be.
I want to know what each of you think of that approach, of
a mandatory opt in or opt out vote every few years to decide
certain matters. Let us start with you, Professor Coates. Since
you seem to have expressed this idea, now I would like to hear
your comments on it.
Mr. Coates. Sure. Thank you for the--obviously, I like my
idea, but----
Senator Bunning. Well, I hope so.
Mr. Coates. ----to explain, I don't think of it as
necessary to prevent imposing Government regulation, because I
don't think that is actually the intent of any of the proposals
that are currently being debated. I do think it would be a good
idea to preserve flexibility in what sorts of corporate
governance structures companies are either required or induced
to adopt, and one way to achieve that is to let shareholders,
who, after all, this is meant to be in the interest of
shareholders, so if shareholders every 5 years are given the
option of rejecting a particular idea on the ground that it is
too expensive, for example, too cumbersome, or simply inapt for
their company, and here I would join Professor Verret in saying
I think that is a reasonable approach.
The key point, though, is it needs to be opt out, because
as I alluded to in my opening remarks, shareholders on their
own, despite the 20, 30 years of efforts by organizations like
the one led by Ms. Yerger, have had a very hard time getting
companies to be responsive. It has been 20 years since proxy
access has been proposed by leading institutional shareholders
and only now is it being taken seriously. So I have to, with
all due respect, disagree with the Business Roundtable's
suggestion that, in fact, corporate boards are generally
responsive to shareholder desires. Start with a good rule----
Senator Bunning. Ms. Cross.
Mr. Coates. Sorry.
Ms. Cross. Thank you, sir. It is an interesting idea and I
think with respect to our proxy access proposal, which is the
one that we have on the table right now, we include requests
for comment in our proposal about whether or not you should be
able to opt out and have the shareholders choose a different
access mechanism, and we very much look forward to receiving
comments on that. This is a proposal as we----
Senator Bunning. How much more time do we have?
Ms. Cross. On the proposal?
Senator Bunning. No, to make suggestions or to comment.
Ms. Cross. The comment period runs through August 16 or 17,
I believe.
Senator Bunning. Thank you very much.
Ms. Yerger.
Ms. Yerger. I have a couple of observations. First of all,
I am not a lawyer, so I come at this from a different
perspective----
Senator Bunning. Good. I am very happy to hear that.
[Laughter.]
Ms. Yerger. Our belief is that the board of directors is
the cornerstone of the corporate governance model and the
primary rights assigned to owners, aside from buying and
selling their shares, is to elect and remove directors. And the
fact is that we do not have those tools here in the United
States. And that is why we advocate majority voting and access
to the proxy. We think these are two principled rules. They are
applicable to all companies at all times.
In terms of an opt out idea, I mean, I don't see how an opt
out would be relevant at all to majority voting for directors.
I mean, I just believe fundamentally that if a director does
not win support of a majority of the votes cast, that director
should not stand----
Senator Bunning. Thank you.
Ms. Yerger. ----on the board. But one quick point on
access. There is already a----
Senator Bunning. I have only got 35 seconds, and I have got
one more question.
Ms. Yerger. OK, sorry.
Senator Bunning. That is OK. This is for Professors Coates
and Verret. Several weeks ago, Professor Henry Hu raised an
interesting problem before this Subcommittee. He pointed out
that with derivatives, the voting rights of shares can now be
separated from the economic right of the shares, setting up a
situation where the person voting has no interest in the long-
term health of the company. What can and should be done about
that? Take a shot at it, both of you.
Mr. Coates. I have a negative 5 seconds.
Senator Bunning. Well, that is all right.
Mr. Coates. That is all right. OK.
Senator Bunning. You get to answer.
Mr. Coates. Henry's issue is a serious one. It is one that
has affected a number of companies in the past--in the recent
years during the financial turmoil because it allows hedge
funds' short-term speculators who have distinctly different
interests than the long-term shareholders represented at this
table----
Senator Bunning. They can have a negative interest.
Mr. Coates. Exactly. Now, I believe that if the SEC is
given time to address the issue adequately, they already
understand that this is a significant problem. There are no
simple fixes to this, just as there are no simple fixes to most
problems in the market.
Senator Bunning. You have not made a suggestion yet.
Mr. Coates. Well, disclosure is usually the place the SEC
does and should start. That is the place where I would start on
addressing the problem.
Senator Bunning. Disclosure.
Mr. Coates. Yes, full disclosure of hedge fund positions.
Mr. Verret. I would echo that disclosure is--that sunlight
is the best disinfectant and that the central mission of the
SEC is disclosure. And, in fact, that is part of the reason why
I am opposed to the SEC's current proposal on proxy access, and
it is proxy access through legislation so that it goes beyond
the central mission of the SEC for disclosure.
Senator Bunning. Thank you.
Chairman Reed. Thank you, Senator Bunning.
Senator Schumer, please.
Senator Schumer. Thank you. I thank all the witnesses. Very
informative testimony. I am going to make two comments--one to
Professor Verret, one to Professor Coates--to which you can
comment in writing, because I do not have much time and I want
to ask other questions.
To Professor Verret, ``Let the shareholders decide,'' as
Ms. Yerger points out, is a tautology. Shareholders do not
decide now, so just saying let us leave it up to the
shareholders and whatever they decide happens happens, in too
many instances they just do not have the ability to decide now.
Our rules are supposed to let them decide, and you are sort of
proposal, well, whatever they say is what they want--not under
these rules. You can respond in writing.
[Ed. note: Answer not received by time of publication.]
Senator Schumer. To Professor Coates, this idea that
financial firms, because they could be bailed out, the
shareholders would have a different structure, I would like you
to ask the shareholders of Citigroup or AIG, former, if they
feel that they have done quite well because they have let risks
go too far and they were bailed out. In other words, most
companies, by the time they are bailed out, their shares are
worth very, very little. And I do not think they would have a
different structure, and I would argue that the recent history
would undercut your argument even further, and that is,
allowing risk--because you are a financial firm and you might
be bailed out allows you to take risk, and that is fine for the
shareholders? They are going to be very wary of risk over the
next 5 years, whether they are bailed out or not, because
shares went way down.
You can respond in writing to that one, but I just do not
think the facts, the recent history bears out that hypothesis.
Response: One of the most basic and widely accepted principles of
corporate finance is that shareholders--who are entitled to all of the
upside if a company does well--would rather that the company take more
risks than do the creditors, who are generally entitled only to receive
back the principal and preset interest on their loans. See R.A. Brealey
and S.C. Myers, Principles of Corporate Finance (5th ed. 1996) at 492
(``stockholders of . . . firms [with debt] gain when business risk
increases. Financial managers who act strictly in their shareholders'
interests (and against the interests of creditors) will favor risky
projects over safe ones. They may even take risky projects with
negative [net present expected value]''). Nothing in the recent crisis
has affected that general conclusion. Higher risk generally means
higher return for shareholders, but for creditors, whose return is
fixed, risk-taking by corporate borrowers just increases the odds that
they will not get repaid in full.
Generally, creditors protect themselves against shareholders
pressuring companies to take too much risk by negotiating for explicit
restrictions in their contracts. For example, a bank loan may forbid a
company from reducing its cash on hand below a set level, or from
making large new investments without creditor approval. The U.S.
Government, as back-stop creditor of all of the major commercial banks
(and, as it turned out, AIG, too, even though AIG was not an insured
bank), tries to protect itself against excessive risk-taking by setting
capital requirements and imposing other forms of regulation on banks.
Existing regulations have not proven effective, and many proposals
under consideration would strengthen those regulations, and limit
further the risks that banks may take with taxpayer funds.
Strengthening the hand of shareholders of major banks may undercut
those efforts.
You are right that not all risks turn out to be good ones for
shareholders, and that there are risks that turn out badly for
shareholders as well as creditors, as has been the case in the recent
crisis. But when the managers of large financial institutions are
making decisions, they do not know how the risks will play out. Imagine
a manager can choose between two investments, each to be financed
partly with $5 of shareholder money and partly with a $5 loan from the
creditor. One investment will pay off $5 100 percent of the time--it
has no ``risk'', but it also promises no return to the shareholders,
since the whole return will go to creditors. The second investment will
pay off $10 90 percent of the time, and will generate a loss of $100 10
percent of the time. The second investment is clearly better for
shareholders, since (in expectation) it is worth $5 90 percent of the
time ($10 less the $5 loan), and -$5 10 percent of the time (loss of
their $5 investment). But the second investment involves a risk to the
creditors (e.g., the U.S. taxpayers) since it involves a potential loss
and an inability by the company to pay back the loan, and is worse for
society as a whole. Suppose the managers nevertheless choose the second
investment, and it pays off badly--i.e., it generates a loss. With
hindsight, shareholders have lost, too, along with the creditors. But
that doesn't mean that the investment was bad for the shareholders. It
is only after the loss has appeared that the investment looks bad. If
they had to do all over again, most diversified shareholders generally
would have the managers choose the second investment. This example is
stylized, but it is no different in kind than the investment decisions
that financial institution managers make every day.
Corporate governance rules are changed rarely--you will be writing
legislation not for the next 5 years, but for decades, through
recessions and boom markets alike, and will apply to a range of
publicly held companies. If the managers are forced by strong corporate
governance reforms to follow more closely the directions of
shareholders, they will tend, on average, to take more risks than they
would if shareholder power were weaker. For most companies, creditors
can take care of themselves, through contract, and in principle, as the
bank regulators can offset any general increase in risk-taking by
managers caused by shareholders, by requiring higher capital ratios or
imposing more restrictive regulations. But the tendency of bank
regulators has been, unfortunately, to fail to impose strict enough
regulations to cope with the pressure of incentive compensation and
other techniques for tying managers' interests to shareholder goals.
General corporate governance changes of the kind being discussed should
be written with that unfortunate fact in mind.
Senator Schumer. Ms. Cross, the SEC has proposed ``say-on-
pay'' for TARP recipients but not for other public companies.
If ``say-on-pay'' is a good idea when the Government is a
shareholder, why isn't it a good idea for all shareholders?
Ms. Cross. Chairman Schapiro has indicated that she
supports ``say-on-pay'' for all public companies, and we do not
have authority to require ``say-on-pay'' at public companies
beyond the TARP companies.
Senator Schumer. But you would be supportive of it.
Ms. Cross. I cannot speak for the Commission, and the
Commission has not taken a position.
Senator Schumer. OK. But Chairman Schapiro is supportive of
it.
Ms. Cross. Chairman Schapiro has said she supports it, and
we stand ready to implement it if Congress enacts it.
Senator Schumer. OK, good.
Mr. Castellani, you note that some of the proposals--and I
think that is significant, and I appreciate that. You note that
some of the proposals in the Shareholder Bill of Rights are
already being adopted by your member companies and reflect an
emerging consensus on best practices in corporate governance.
Well, if that is the case, then what are you so afraid of? If
this is the trend anyway, if you seem to indicate this is the
right thing to do, what is wrong with pushing those--you know,
I had a discussion with one of your members, and I will not
reveal who it is, but he said, ``Look, I am not''--and then he
named his predecessor. ``You do not have to legislate for me.''
I said, ``That is my whole point. We are not legislating for
you. You are a good CEO, and whether your shareholders made you
be a good CEO or not, you would be. But what about your
predecessor?''
So, question: Doesn't the Shareholder Bill of Rights create
a competitive advantage for the companies that follow the best
practices? And why does the Roundtable, most of whom comply, I
think overwhelmingly, with some of our proposals, and many
comply with just about all of our proposals, why are they going
so far to defend the outlier companies for whom the laws are
needed most?
Mr. Castellani. Senator, in fact, many of the Roundtable
companies do and have adopted many of the practices that are in
your proposal. The difference--
Senator Schumer. And you cite that with pride.
Mr. Castellani. Yes, absolutely. The difference is those--
--
Senator Schumer. That is not a very good argument against
my proposal.
Mr. Castellani. Well, those who have not have made--those
who have and those who have not have made the determination
that that is best for their company. Their directors have made
that determination, that that is best for their company under
their circumstances.
For example, the issue that you cited in the separation of
the chairman and the chief executive officer, in some instances
it makes very good sense to separate the chairman and chief
executive officer, particularly where it is a transition event.
But in other circumstances, boards feel that it makes best
sense to have both together, but protect against the downside
by having a presiding director or----
Senator Schumer. As I mentioned--and I am----
Mr. Castellani. So the question is: Why require it?
Senator Schumer. I do not have much time, and I cannot stay
for a second round. I am going to have to ask you another
question. I understand. I mean, the one, as I said, that got
the most kickback and that I am open to listening to change on
or proposals on is the CEO and the independent director. You
noted that 75 percent of your member organizations, 70 percent
of S&P 500 companies, have adopted majority voting, and roughly
half of the S&P 500s now hold annual director elections. Yet
you argue that the one-size-fits-all approach simply will not
work.
Can you give me one good reason that a director who gets
only one vote at an annual meeting should be allowed to
continue as a director?
Mr. Castellani. I cannot give you any good reason why any
director who does not receive a majority vote of the
shareholders should be seated, unless--unless--it jeopardizes
the ability of that company to be able to operate and that
board to operate.
For example, many companies who have adopted majority
voting put in a safeguard for their companies such that if they
require that particular director--that may be the only director
that has the financial expertise that is required on the audit
committee, the only director that would have the compensation
expertise that is required on the compensation committee. If
that would force the company to be in noncompliance, then what
companies do is----
Senator Schumer. How about take away that exception? Any
other justification? Let us assume we wrote into the law----
Mr. Castellani. Not as long as the board can function and
the company can function.
Senator Schumer. OK, thanks. Well, good, we have won you
over on at least two-thirds of one of our proposals.
Mr. Verret. And, legally, Senator, I would offer that
failure to seat a quorum could result in a wide variety of
legal circumstances, including, for instance, it could be an
event of default under the company's debt obligation.
Senator Schumer. I am sure we could deal with that,
particularly with the quorum issue, in the interim until there
was another election.
Thank you, Mr. Chairman. My time has expired.
Chairman Reed. Thank you, Senator Schumer.
Senator Corker, please.
Senator Corker. Thank you, Mr. Chairman, and to the Senator
from New York, I appreciate you offering something to look at.
I do want to observe the staggered board issue I think has
not been universally accepted, and I think we have a body on
the other side of the Capitol that does not have staggered
boards, and sometimes things come out of there pretty hot, like
the 90-percent tax on the AIG bonuses. So I think there is some
merit in that and hope you might consider that particular piece
evolving. But I want to say one other thing.
Professor Coates, I know that to assume that the folks who
own AIG today are the same folks who might have encouraged the
risk would not be a good assumption. I mean, those guys sold
out high, and the folks that are left behind--so, again, I do
not think you can make that assessment. So I hope we can look
at some of those things, and I look forward to really trying to
work with you on something that we both might consider to be
improved.
We talked to Carl Icahn on the phone some time ago--I
shared this with Senator Schumer--and he is obviously someone
who cares a great deal about corporate governance. He has
written about this, or I would not relay our conversation. It
is certainly something he publicly feels. But the whole issue
of where companies are incorporated seems to be an issue that
is maybe even bigger than anything that has been laid out
today. And I wonder if a couple of you might respond to that.
Obviously, companies incorporate in States in many cases
that give them many protections and keep shareholders from
being able to make huge changes. And I wonder, Professor Coates
and Professor Verret, if you might both respond to that, and
anybody else who might have something salient.
Mr. Verret. Well, I am aware that Mr. Icahn has funded
North Dakota's Business Incorporation Act. He hired a lawyer to
write it for him, and he hopes to get companies to
reincorporate to North Dakota.
Having clerked for the Delaware Court of Chancery, I am a
bit biased. I think Delaware is a very effective court for
litigating corporate governance issues--mostly due to the
intelligence and superior talent of their law clerks. But I
would also offer that, to some extent, I think some of what is
behind some of this effort is short-termism, some of the short-
termism that got us into this problem in the first place: Let
us cash out on dividends rather than invest in R&D.
And sometimes hedge fund activism is very effective in
long-term growth and in sort of rattling the saber a little bit
and getting things moving. And sometimes hedge fund activism,
though, kills companies that should continue to survive and
strips them of their assets. And so I think that is part of
what is behind the approach.
Also, I think we----
Senator Corker. In essence, then, you are saying that you
like some activism on behalf of shareholders, but not too much.
Mr. Verret. Absolutely, and I am a little bit suspicious of
Mr. Icahn's motives, at some of his activism in activism in
favor of State incorporation.
Senator Corker. Thank you.
Mr. Coates.
Mr. Coates. So it has been true for a long time that
shareholders cannot force a reincorporation from one State to
another on their own. They need the board to go along with it.
And the board cannot do it on their own; it has got to be a
joint decision. And as a result, there is actually relatively
little movement between States once they have chosen their
initial State of incorporation.
At the moment before they go public, that is really the
crucial decision point, and for that reason I think that fact
that Delaware has a 70-percent share of the market, so to
speak, it reflects well on Delaware. I think it is actually a
reasonably healthy sign that Delaware is being responsive, as
best it can, to balancing the interests of both shareholders
and the managers that have to run them.
One thing, however, I would note about Delaware and its
permissiveness toward a little bit of activism is it only
passed that enabling legislation in the past year, and it did
it in response to the threat of Federal intervention coming
from this body. And so I do not think you should think about
Delaware acting on its own to help shareholders. I think you
should think about Delaware acting in relationship to this
body, and things that you do are going to very much impact it.
Senator Corker. Mr. Castellani, I have served on several
public company boards, certainly not of the size of AIG or some
of the other companies we have had troubles with. But I do not
think there is any question that boards in many cases--not all,
and yours, I am sure, is not this way. But it ends up being
sort of a social thing. I mean, you are on the board because
the CEO of this company and the CEO of that company is on the
board, and, you know, it is sort of a status thing in many
cases. The CEO in many cases helps select who those board
members are. And most of the time these board--many of the
times, these board members have their own fish to fry. They
have companies that they run, they are busy with, and, for
instance, a complex financial institution, there is no way,
like no possible way that most board members of these
institutions really understand some of the risks that are
taking place. With the limited number of board meetings, even
if they are on the audit committee, very difficult to do.
So some of these things need to be addressed certainly by
governance issues that we might address here, hopefully not too
many. Some of them need to be addressed, obviously, internally
at the companies. I know you have advocated that in the office.
But that issue of sort of the culture of the way boards in many
cases are. Not in every case. I wonder if you might have a
comment there, and then add to that--I am familiar with a
company that makes investments in large companies, and one of
the rules they have is they do not allow the CEO himself to
actually serve on the board. They report to the board. They are
at the meeting. But they do not allow them to serve on the
board. So I would love for you to respond to both of those
inquiries.
Mr. Castellani. I think, Senator, for your first question,
what you are reflecting may have been the experience when you
served on the boards. But what I think it does not reflect is
the tremendous change that has occurred in the boardrooms over
the last 8 years.
We now see boards of directors, in the case of Business
Roundtable companies, that are at least 80 percent independent,
and that is, the directors are independent of the company
management.
Indeed, the governance committees or the nominating
committees that nominate the directors by requirement of the
listing standards and the SEC are made up entirely of
independent directors. So the nomination of a board member, a
prospective board member, is no longer--if it indeed every
was--controlled by the chief executive officer.
And then, third, I would point out particularly the amount
of time that is involved and the amount of expertise that is
involved. It is not only the specific requirement of the
expertise that is in the listing standards and the SEC
requirements, but indeed what boards themselves are demanding
and what companies and their shareholders are demanding has
resulted in not only greater expertise in specific areas, but a
tremendous increase in the amount of time.
For example, I was recently talking to the chair of the
audit committee of a large U.S. company. That chair spent 800
hours of, in this case, his time as the chair of an audit
committee over the last year because of some very complex
financial issues. So the board members are spending more and
more time. So I would submit to you, sir, that it is very
different than when you served on the boards.
And in terms of the boards being able to have the CEO as a
member of the board, the CEO as a member of a board, in fact,
the CEO and chairman where companies choose it, is a very, very
important nexus between the governance of a corporation and the
management of a corporation.
We have found and experience has shown over a long period
of time that if you separate the governance from the
management, you get precisely the kinds of problems that this
Committee is trying to avoid. So having the CEO on the board is
a very, very important nexus. In many cases, companies and
boards believe that having the CEO as chairman of the board is
also very important.
Again, my point would be what I have said in my testimony:
That is up to every company to decide, and their board of
directors representing the shareholders to decide, rather than
be prescriptive, because it is not always right, but it is
always right for the company that makes the right decision, and
they should be allowed to make that decision.
Senator Corker. Thank you.
Chairman Reed. Thank you very much, Senator Corker.
Senator Menendez, please.
Senator Menendez. Thank you, Mr. Chairman. Thank you all
for your testimony.
Let me ask you, I understand that in a previous question,
most of you--I understand just one or two objections, but most
of you said that you support the SEC's May 20th rule to allow
certain shareholders to include their nominees and proxies that
are sent to all the other shareholders. Do you think that goes
far enough? Or is to too far? If you support it, I assume that
it goes far enough, it is sufficient. But is there something
that should be done than that? Does that embody what we want to
see?
Mr. Ferlauto. Senator Mendendez, I think it is an
appropriate use of rule making, which is purely disclosure-
based, which is very important; that is that it leaves up to
the States the creation of rights in terms of the nomination of
directors, but it empowers shareholders to be informed through
shareholder communications about the fact that those elections
are indeed occurring, and then votes through the proxy
materials on that right. So I think that is a good balance.
In addition, something that we have not talked about, the
rule goes further, and it empowers shareholders to make binding
bylaw amendments to improve those shareholder rights for the
election of directors so that this disclosure right at 1
percent--or actually it is a tiered system that they have in
the disclosure rule right now for comment--becomes a floor of
disclosure, and then at the State level, through an election
system based on a shareholder proposal or a board proposal,
they can increase or tweak that right in an interesting way.
For example, I talked about ShareOwners.org being
interested in retail shareholders. They can never hope to get 1
percent. But as in the U.K., you might be able to get 100
shareholders, retail shareholders, each owning $5,000 or
$10,000 worth together who might be an appropriate group to
create different types of rights.
So that there is flexibility, which I think is quite
welcome.
Mr. Verret. Senator Menendez, I would offer that
Commissioner Paredes of the SEC has offered a competing
proposal to the Chairman's proposal, and I think Commissioner
Paredes' proposal is much more reasonable in that it considers
facilitation of State law rights rather than running roughshod
over them and sort of keeping the lion's share of the meat and
leaving the table scraps for the States. And I think
Commissioner Paredes' proposal also strikes a balance in
limiting the ability of special interests to hijack the
corporate ballot. And so I would offer that for this
Committee's attention.
Senator Menendez. Does anyone else have any opinion on it?
Mr. Castellani. Yes, Senator, I was not one of the majority
who supported that, and I just wanted to make sure that you
knew that.
Our concern is that what the SEC is proposing to give
access to the shareholders does preempt what has been
traditionally done in the States. And, quite frankly, we think
that there is symmetry in the argument that says if we trust
the shareholders to elect the boards of directors, which we do
implicitly, then we ought to trust the shareholders to set the
threshold at which shareholders can nominate those board of
directors candidates.
Ms. Yerger. I would just note that, as I said earlier, we
think this is a core right that should be federalized. The
States have failed investors too long, Delaware in particular,
and it really only acted when it had to. And I think it is
important that the SEC take action on this important reform.
Senator Menendez. Let me ask in a different context. In
practice, a corporation serves multiple masters, right? It has
shareholders, it has corporate management, its creditors, the
public in general. There are many cases where what is best for
corporate management may not necessarily be the best for
shareholders. Or there are also cases where what is best for
shareholders is not what is best for the general public or the
financial institution as a whole.
How do we reconcile those tensions?
Mr. Castellani. That is a very interesting question that
has been discussed--I am the oldest on the panel, so I can say
this--for at least most of my corporate career.
Senator Menendez. There is no one seeking to claim
objection, I notice.
[Laughter.]
Mr. Castellani. I am used to it.
Senator Menendez. You have created compromise already.
Mr. Castellani. There was particularly a very important
topic in the 1980s, particularly when there was as lot of
activity related to hostile takeovers, and that is, to whom is
a board of directors and a management responsible? And the
argument was a stakeholder argument, that there were
shareholders, there were employees, there were communities,
there were suppliers, there were customers, all of which had a
legitimate position in the decisions.
I would think it is fair to say that in the 1990s and the
early part of this decade, that balance switched more to the
shareholders, but what happened is the nature of the
shareholders has changed very, very considerably. And that is,
the average holding period, for example, of a New York Stock
Exchange-listed company is about 7\1/2\ months. So if your
management and your board--you are really dealing with share
renters and traders as much, if not more, than shareholders.
And I think what we are all discussing here and we all have a
perspective on is: Going forward, what is the correct balance
between those who have a very, very short-term interest in very
quick gain out of a company and may want to do some of the
things that have been discussed here? You give access, you give
rights to small percentages of shareholders. We already know in
many cases how they act. Some funds come in and say, ``We own 5
percent of your company. What we want you to do is leverage the
company, buy back the shares, give us about a 10-or 20-percent
jump, and we are out of here, quickly.'' As opposed to other
shareholders who say, ``I think there is a value-added.''
I do not know that anybody is in the long term. I do not
know that any of us know the right answer to that. But I think,
quite frankly, that is the question that is at the crux of what
this Committee should be looking at. Obviously----
Mr. Ferlauto. And, Senator, I--interestingly enough for
here, this is where the Business Roundtable and certainly
AFSCME, and I think some members of CII agree. It is all about
how you empower long-termism and long-term shareholders, which
we believe that proxy access ultimately will do, so that the
best interests of the company to achieve long-term shareholder
value is achieved. And the way you do that, actually, in terms
of this long-termism, is getting into the DNA of the board. How
does the board become most effective by being diverse, by being
able to absorb many different points of view, by being--to
evaluate itself to make sure that it is focused on long-term
strategic implementation and that CEO pay incentives are
aligned with that long strategic vision? And when we see a
company that fails, we see a failure in all of those areas,
which is bad for the shareholders, which is bad for the
employees, which is bad for management, and for all other
stakeholders in the process.
So we want proxy access to fix boards because they cannot
self-evaluate, because they are not diverse enough to share the
interests of their stakeholders, which ultimately they need in
order to achieve long-term shareholder value, and because their
DNA is warped enough that it only serves management or a
minority of shareholders and not achieve value for the long
term. And that is the very essence of why we want proxy access
and we need it now.
Senator Menendez. Thank you.
Mr. Verret. Senator, may I just also add quickly, I want to
commend Senator Warner and Senator Corker for the introduction
of the TARP Recipient Ownership Trust Act. Shareholders and
boards are complicated enough. When Government becomes a
shareholder, things become even more tricky, and I want to
commend the introduction of that act as dealing with some--
going down the road to dealing with those unique conflicts.
Chairman Reed. Thank you very much. Thank you, Senator
Menendez.
Senator Johanns.
Senator Johanns. Mr. Chairman, thank you. To all the panel
members, thank you very much for being here.
What I am trying to figure out as I listened to this very
interesting dialogue between the Senators and each of you, is
this: I kind of look at this as maybe a little bit black and
white. There are big players here, and there are small players
here. But they are all affected by the decisions we make here.
Now, Mr. Ferlauto, if I could start with you, how much
money do you have under investment, say at this point in time?
Mr. Ferlauto. AFSCME itself is a rather small player. Our
employee pension system itself has got less than $1 billion in
it. But most importantly is that we are concerned about the
retirement security of our members, and our members depend on
well-functioning capital markets and boards to achieve value.
In order for them to pay the benefits, all of our members want
a market that will succeed, that has got the ability to achieve
a value over time. We are not speaking and we are not active on
the part necessarily of what is in our portfolio, but what is
in the interests of not only our members, but all American
families seeking to achieve long-term financial security. And
those are the people that I speak on behalf of.
Senator Johanns. Great. Well, I have never had $1 billion
under management, so I see you as a big player. What if some
institution out there who has $1 billion under investment or
$10 billion, or whatever--let us say they are a big player,
like I think you are. Let us say you decide that you think the
worst possible course of action for a company is to be pro-
trade, and there are some that very openly espouse that theory,
that trade has really cost jobs and hurt America and this and
that.
If you have access to the proxy, you then have the right to
elect somebody who espouses that view. Would that be correct?
Mr. Ferlauto. No, not necessarily. What we have the right
to do is to potentially nominate somebody, but in order for
somebody to be elected, they would have to be elected by a
majority of everybody who is voting, and then presumably all
the owners, as in a regular election, would assert their
choices based on what is in their self-interests. So that I
would assume that a minority player working on any--you know,
any motivated self-interest would not be able to achieve
victory.
Senator Johanns. Here is what I am trying to get to, and I
am not trying to be coy about this. I am trying to be very,
very direct about this. I have got 100 shares; you have got $1
billion worth of shares. I am pro-trade, let us say, and
whoever this institution is--I am not say AFSCME is this, but
whoever this institution is, it takes a very, very different
view than I do that may not be in the best interest.
Mr. Ferlauto. It is actually a very good point, but who I
am concerned about are actually the large financial
intermediaries, particularly mutual funds, who are seeking to
do business, you know, with other large companies to sell their
investment products through their 401(k) plans so that they
actually may cast their votes in a way that would be looked
kindly on by the CEO because they are not voting against his
compensation plan, rather than voting in the interests of all
the small individual investors who put their money into that
fund, you know, thinking that that is the way to achieve value.
And those are the kinds of conflicts that are rife in this
system that we are very concerned about.
Senator Johanns. Yes, and I am going to be very direct
again. You and I are going to have an easy time agreeing that
there are a lot of ways to be self-interested. A lot of ways.
So, Mr. Castellani, let me turn to you. Based on your corporate
experience, what impact does that have on your company if there
is, for lack of better terminology, ease of entry here?
Mr. Castellani. One of the things that we are concerned
about is that it would politicize the board. The board is
legally required to represent all shareholders. So each member
of the board is to represent all shareholders, not a
particularly constituency of shareholders. But, in fact, there
are constituencies of shareholders, people who want short-term
gains, people who want--you were giving an example, my company,
Tenneco, owned Newport News Shipbuilding. We had a shareholder,
a nice little group from Connecticut, a group of nuns who owned
$2,600 of the company and wanted us to get out of the nuclear
shipbuilding business. And every year, they would have that on
the proxy.
The point is that dissension first costs the shareholders
money, because that is who pays for the proxy process. It
doesn't come out of the management's pocket. It doesn't come
out of the Government's pocket. The shareholders pay for the
dissension.
But second--directly, they pay for the proxy process--but
second, boards best operate when they operate by consensus,
when there is an agreement among the board of the strategic
direction of the company and who should implement that
strategic direction. It doesn't mean there isn't discussion. It
doesn't mean there isn't questioning, that there isn't
dissension. But when they make a decision, companies operate
best when you don't second-guess, until there is reason to
second-guess, the direction the company is going.
Senator Johnson. I am out of time, and I won't press that
too much today because we have been given extra time today, but
I want to offer one other thought on a totally different
approach. I was on a panel yesterday in this room, and as I
started my questioning, I said to the panelists, I said, I am
going to warn you. I am a former Governor. It just astounds me
how we have this philosophy here--and I am very new to this
Senate job--it just astounds me how we think all of the best
solutions are here in Washington with a Federal approach. This
really does impact States in a very, very significant way. That
in itself is a very, very profound issue. And yet we just kind
of jump right in the middle of it with this new approach that
just casts aside 50 State corporate laws.
And I will share this with you. When I started as Governor
many years ago, I decided that I wanted to be a State that
attracted business to my State. We needed jobs and we needed
economic growth in the State of Nebraska and I decided I was
going to take on Delaware to try to make that happen. You know
what I realized about Delaware? They had one heck of a good
start and they were doing more things right than they were
doing wrong and it was going to be very, very difficult to dent
that.
And yet in this hearing, again, whether it is Delaware or
Nebraska or Wyoming or California, whoever, we have a very,
very profound impact on the history of corporate governance in
this Nation and I just don't think we should do that lightly. I
think you would have 50 Governors in those seats back there
ready to come to the table to chew on us about that, because it
does have very significant consequences for the States where
the jobs do exist, where the jobs are created, where hopefully
the businesses grow and expand and create economic
opportunities for the people out there who then pay the taxes
that allow us to come here and do the social and other programs
that we just love to do.
So I just think it is really an important philosophical
issue and that is my little sermonette at the end of the
questioning. Thank you.
Chairman Reed. Thank you, Senator Johanns.
Let us begin the second round.
Ms. Yerger, what is the status of majority voting on
Delaware law now? Is it----
Ms. Yerger. Under Delaware, and again, I am not a lawyer,
it is not the default standard, but the laws do accommodate
majority voting so companies can adopt it voluntarily.
Chairman Reed. They can adopt it voluntarily. But under
the--and Ms. Cross, under the SEC's proposal, that would not
upset Delaware law if you were talking about majority voting.
It would be optional.
Ms. Cross. We don't have a proposal on majority voting. The
way it would work with our proxy access is that if there were
more people running than there were slots, you would usually
revert to plurality voting because majority wouldn't work.
Chairman Reed. OK. Thank you.
Mr. Castellani, again, thank you for being here and for
your testimony. I think the core of the issue is who knows best
about the company, the directors or the shareholders. Under the
present arrangement, and we have got enough lawyers who can
criticize my legal analysis, is that the directors essentially
control access in most companies to the proxy unless you want
to mount a very expensive proxy fight. They decide in most
cases and in most companies what will get on as an issue and
what won't get on as an issue. So the current practice, unless
we do something, will leave sort of the directors with critical
control of the process and then on both sides of this argument
we are talking about empowering shareholders. So your comments,
and then I will open it up to the panel.
Mr. Castellani. Sure. First, for the record, let me state I
am a scientist and engineer, not a lawyer.
Chairman Reed. Well, Senator Bunning, again, thank you on
his behalf.
Mr. Castellani. I want to say that as often as I can.
In fact, the directors do not control access to the proxy
for all issues. In fact, the SEC controls. Therefore, companies
like Tenneco get proposals. All companies get proposals related
to social issues, governance issues, economic issues, labor
issues, environmental issues. But I don't think that is what
you are talking about.
What you are talking about is the access for the purposes
of nominating directors and we have to talk about that in the
context of any group of shareholders, any single shareholder
has an ability, if they can afford it, and it is an expensive
proposition----
Chairman Reed. Yes.
Mr. Castellani. ----to nominate directors and run in
competition to the directors that are nominated by the
Nominating Committee. That is how we do takeovers and that is
how the companies make sea changes, or investors make sea
changes.
What I am concerned about and what we are concerned about
is we have, by majority vote, by and large, directors who are
elected to represent all shareholders. Those directors are, by
and large, elected every year. And so if the shareholders elect
the directors and the shareholders can remove the directors
under majority voting, then how does the company best operate
on behalf of the shareholders?
Is it best operated in letting those directors make, in
their collective judgment, decisions about who should be on the
board representing the shareholders, who should manage the
company, or do we subject those directors or a portion of
them--a significant portion, 25 percent of them--to a
reelection challenge every year and turn them into essentially
corporate politicians, because these are contested elections.
They are somehow going to have to be run as contested
elections.
And what does that do to the director? Does that then
distract her from the business that we all want her to do,
which is overseeing the shareholders' interests in that board
room, or does she have to be more concerned because the
conflicting nominee was elected because they didn't want us to
be in the nuclear shipbuilding business, in my case, or they
didn't want us to do business in a particular part of the
world, or they wanted our product lines to change, or they
wanted some practices to change.
What our concern is is that boards should be free to do and
responsible for doing what the shareholders want them to do,
and that is be good stewards of their investment in the
company.
Chairman Reed. Well, my sense is--and you are right to
narrow down my focus to the directors' election because social
issues, they do get on the board because the SEC has required
that and there is an argument they could require the directors
also to be subject to proxy access.
But the other side of the argument is there is a group of
directors that essentially nominates the Nominating Committee.
Usually the Nominating Committee is directors----
Mr. Castellani. Right.
Chairman Reed. ----who then choose other people they think
are sympathetic to them and their views and the shareholders,
unless they are not in a proxy fight, generally they either
have to accept this board, and many times, as you pointed out,
the board is not elected by a majority. In fact, there are many
times where less than a majority of shareholders, a small
number of shareholders even vote, and I think there has been a
lot of discussion back and forth about motivation for voting,
but most shareholders don't know--it is not the politics as
practiced elsewhere. Most shareholders are reflecting on their
dividends, their share value, what they think the company
should be doing economically for their benefit. It is quite
self-interested.
Mr. Castellani. I think, Senator, another point I should
make--two other points I should make is that good boards, and
certainly I would include our companies, have means by which
they communicate and allow shareholders to suggest directors.
And in fact, that is something that all of our member companies
do now.
So small groups of shareholders--and let us not kid
ourselves. I mean, any management, any board that is worth
anything, that can wake up and make their own breakfast in the
morning, when a large shareholder comes in and says, we want to
talk to you about the make-up of the board, by God, we listen,
because you forget, we are in the business of trying to sell
our shares to members and convince investors that we are a good
company to invest in. So we listen to investors.
The problem that we have is that sometimes in these
discussions, you are talking about individual investors and we
have to be responsive to our largest investors, which are
institutional investors. And so the desires of individuals come
through intermediaries, the mutual fund and the fund managers,
and that message is very different than what some of the things
that you are describing.
Chairman Reed. This is a conversation that could go on at
length, but I am going to stop and recognize Senator Bunning.
Thank you.
Senator Bunning. Thank you very much.
Professor Verret, there has been a lot of talk about giving
shareholders a vote on pay packages but little discussion on
the details. If we were to require such a vote, what
specifically should we vote on and how often should we vote?
Mr. Verret. Well, notably, I think one thing I would draw
out is that there is a big difference between ``say-on-pay''
and say on severance packages. I think those are two distinct
issues. There is a healthy debate about both of them, but I
think it is a mistake to lump them in together. I think the big
difference between say on severance is that severance packages
are used to facilitate efficient mergers and acquisitions.
Basically, sometimes when a good M&A deal goes through, the CEO
of the target has to go. It is, you have got to leave and here
is some walking-away money. And those deals are great, and most
of the----
Senator Bunning. But that isn't my question.
Mr. Verret. OK. So my first answer is, I would
differentiate ``say-on-pay'' and say on severance.
With respect to ``say-on-pay,'' I think one of the details
is how often would you approve ``say-on-pay,'' and I am aware
that the United Brotherhood of Carpenters, at least, wants it
every 3 years. I think some groups prefer it every----
Senator Bunning. Every 3 years?
Mr. Verret. Yes. They would prefer the pay package----
Senator Bunning. By the time the second year came around,
maybe the company would be in Chapter 11.
Mr. Verret. Well, perhaps, but what they propose is that
typically, pay packages are negotiated over longer terms, so
``say-on-pay'' should be negotiated over the longer term. You
don't necessarily reapprove the pay package every year.
Sometimes they are longer term. Sometimes they are 5 or 10
years.
So one of the things I would suggest is that you leave open
the boards of directors and the shareholders to determine how
they want ``say-on-pay'' to work.
Senator Bunning. Then you think they should be left open to
the boards in negotiating with whoever they want as their CEO?
Mr. Verret. I worry about the effects of one-size-fits-all
packages, and I think we have seen that effect in Britain with
their ``say-on-pay'' rules.
Senator Bunning. And you think the negotiations on golden
parachutes should be different completely?
Mr. Verret. They should be, because sometimes you have to
do them very quickly, not enough time to get approval for the
package to deal with the specific merger.
Senator Bunning. Would you like to comment?
Mr. Coates. Very briefly. ``Say-on-pay'' is advisory votes
only. There is no need for speed. There is no need for prior
voting. The U.K., the Netherlands, Australia have successfully
implemented this for years, and in fact, the evidence from the
U.K. suggests that it almost never has a bad effect on
companies, that almost all of the time, shareholders approve
the pay package as presented. There are a few outliers that get
their pay packages voted down and the result of that has been a
better alignment of shareholder and manager interests over the
past 5 years in the United Kingdom. So I think the U.K. model
is working and I think it is a reasonable place to start.
Mr. Verret. Although as I am sure Professor Coates might be
aware, the shareholder electorate in the United Kingdom is very
different from the United States--
Senator Bunning. No. This is not a discussion between--we
have to ask the questions.
Mr. Verret. Sorry. He is my old professor and he gave me a
``B'' in corporate law, so I have to----
Senator Bunning. A ``B''? That is pretty good.
[Laughter.]
Senator Bunning. Unbelievable. I will give you a chance to
talk again.
As States respond to concerns about corporate governance
issues with changes to their own laws, is there really a need
to federalize business law?
Mr. Verret. Well, I would agree, and I think we haven't
even had time to see the effect of the State changes on proxy
access operate after Delaware and the other States facilitated
majority voting in 2006. From 2006 to 2007, we saw an increase
in majority voting at companies from 20 percent of the S&P 500
to 50 percent. So Delaware just amended its code in, I think,
March, and the ABA is about to change the Model Business Code.
So there hasn't been enough time to see, I think, all the proxy
access bylaws that I think we are going to see adopted by
boards.
Senator Bunning. Ann, would you like to comment?
Ms. Yerger. I firmly believe that the problem here are the
problem companies and----
Senator Bunning. Yes, we know about them.
Ms. Yerger. ----and that is why I believe these issues
should be federalized, frankly.
Senator Bunning. Yes, but they are at the trough every time
they have a problem, whether they are a finance company or
whether they are an insurance company, whether they are an auto
company. If you think they are too big to fail, then the
Federal Government is the backstop. And if they are a GSE, we
are the backstop for sure. So do you have some other
suggestions that we might not have to be the backstop?
Ms. Yerger. Suggestions regarding specifically--I am sorry.
I have lost the question here.
Senator Bunning. You lost the question. Well, about the
laws being changed in the States on corporate governance.
Ms. Yerger. I feel that majority voting, we have had plenty
of experience and the fact is that there are many companies--in
fact, most small companies have not adopted it. We think it is
a core owner right and as a result it should be federalized.
I also believe that proxy access should be federalized. The
fact is, when council members invest in domestic companies,
they are not doing a portfolio of Delaware companies or
Nebraska companies. They are doing a portfolio of the U.S.
companies, and we either make a decision that these are basic
rights we should be offering to owners of any company here in
the United States or not. And I think the Council firmly
believes that----
Senator Bunning. The fact that if I live in Kentucky, where
I live, you want me to come in and say, the Federal Government
should make the rules for every company in Kentucky.
Ms. Yerger. Regarding access on majority voting----
Senator Bunning. Yes.
Ms. Yerger. ----yes, sir.
Senator Bunning. You do.
Mr. Ferlauto. If I may, another----
Senator Bunning. It won't sell.
Mr. Ferlauto. Another approach to this which I think might
sell is that give shareholders the power to decide what State
they will incorporate in, and therefore you can----
Senator Bunning. Well, they do have the power.
Mr. Ferlauto. No, they don't, actually, is that right now,
it is the boards through the IPO----
Senator Bunning. Oh, you mean beforehand, before they
incorporate.
Mr. Ferlauto. Maybe every 5 years. You talked about one way
to do this is to give them a right every four or 5 years,
similar to Mr. Coates's idea, that rather than opting in and
opting out of a variety of laws, they actually have a right to
decide on whether the charter and powers of a particular State
are appropriate for them at a particular moment and allow
shareholders to decide on their own----
Senator Bunning. You, as a billion-dollar investor, you as
a person who controls $1 billion worth of investment, would say
that to the shareholders after the fact, after they have
already incorporated?
Mr. Ferlauto. I agree that there should be more--that the
State of incorporation should be a greater factor when IPOs are
made and that there is not enough emphasis or focus on
corporate governance during the IPO process, and I think that
would be something very interesting for the SEC to look at for
perhaps new rule making. But if you are talking about
empowering the States, one thing that you might consider to do
is to give them real power and create real competition among
Delaware and Nebraska and North Dakota and California and every
other State by making State corporation real and let them
compete. The only way you can let them compete is by giving
shareholders, the owners of these companies, real power to make
a decision about what laws are most appropriate to them.
Senator Bunning. It won't sell.
Mr. Ferlauto. It is a market-based----
Senator Bunning. It won't sell. We can't sell it, because
we would have 50 Governors up here every day trying to tell us
to mind our own business.
Mr. Ferlauto. Yes, but----
Senator Bunning. Thank you. Thank you, Mr. Chairman.
Chairman Reed. Senator Corker.
Senator Corker. Thank you all for your testimony, and
again, both of you, for having the hearing.
I think what--well, based on backgrounds, Mr. Ferlauto and
I might have a difference of opinion on many things. I think
what you were trying to communicate is giving shareholders--you
can domicile. You can change the corporate domicile at any time
you wish. It doesn't matter where you are incorporated.
I actually think that Senator Johanns was referring to a
race to the top and I do think that, while I realize my friend
from Delaware may disagree, it actually does give shareholders
the ability to influence things and I hope that we will--I am
not sure it wouldn't sell and I hope it is something we will
understand. I am not sure I understand enough about it myself
to support it, but I do know that it certainly would give
shareholders much greater freedoms.
I do want to say to you, Mr. Verret, that I think you were
dead on in your opening comments that here we are talking about
lots of things, but really what has driven this has been moral
hazard, has been what happened with GSEs, and many of the
policies we put in place here, the failure of regulators,
short-term thinking, credit-rating agencies that didn't do what
everyone thought they were doing, and I am not sure about the
mark-to-market issue. We might debate that some.
But I hope that we don't go overboard with what we do here
because it is other factors--many other factors--that have
created this. I do, on the other hand, think that boards are
the final governance issue, and if you have good boards that
actually understand the risk, especially at financial
institutions, I think we might actually look at differentiating
things that have to do with large companies, financial
companies that offer systemic risk. We may look at those a
little differently.
But let us get down to this risk. Senator Schumer is close
to our Chairman. My guess is that just knowing how things work
around here, that he may to defer to him on some of these
corporate governance issues. He laid out six things. My sense
is that the shareholder ``say-on-pay'' issue as advisory was
not particularly controversial amongst most here, is that
correct, as an advisory issue.
The shareholder input didn't seem to be----
Mr. Castellani. Why do it every year? Why require it for
all companies?
Senator Corker. And maybe there is a size issue. By the
way, I am not agreeing myself necessarily with all these. I am
just asking you all. The independent chairperson seemed to be
somewhat agreed by half and somewhat disagreed, especially Mr.
Castellani, is that correct, thought that was a bad idea.
Mr. Castellani. We believe that it should be up to every
board of directors and every company to decide what is best for
them.
Senator Corker. Does anybody other than him disagree with
what was put forth there?
Ms. Cross. If I could note, I am not--on behalf of the SEC,
I am not expressing views. The Commission hasn't expressed
views on all these points.
Senator Corker. I understand.
Ms. Cross. By my silence, I am not commenting.
Senator Corker. I have got you.
Ms. Cross. Thank you.
Ms. Yerger. We are believers in one-size-fits-all on this
issue.
Senator Corker. You are believers in that.
Ms. Yerger. Yes.
Senator Corker. The stagger board issue, I hope stays in
place and is not eliminated, personally. The majority voting
issue didn't seem to be a big issue to anybody here. Mr.
Castellani, since you represent----
Mr. Castellani. Most of our members have majority voting.
Senator Corker. So not a big deal. So the risk committee is
the one issue I think we haven't touched on----
Mr. Castellani. It is very important.
Senator Corker. ----and I just wonder if, since I think we
have got pretty good input from you all in these other areas,
what are your thoughts, in whatever order you want to give
them, on the risk committee issue?
Mr. Castellani. Senator, if I might start, I think there
probably is going to be pretty close to--well, I don't know
whether we would all be unanimous. The fundamental issue, which
is whether or not a board of directors should regularly and
thoroughly analyze the risks that face the company and its
shareholders is not one on which there is any argument. That is
one of the fundamental purposes of a board of directors.
What Senator Schumer in his bill prescribes, however, is
not appropriate, and that is that you create a separate
committee to do that. Some companies choose to do it within
separate committees, but other companies think that it is
better done within its audit committee because its greatest
risk may be in its financial structures. Some companies do it,
because of the nature of the products, in different committees
because their greater risk may be either the products or the
markets in which they serve as opposed to financial risk.
So our suggestion is that it is done, but don't specify
that you create another committee, particularly where we have
already run the risk of being so prescriptive to how many
committees and what type of committees boards should have that
we run the risk of being the best at governance compliance and
the worst at governance implementation.
Senator Corker. I understand. Is there anybody that
strongly disagrees with the position he just put forth?
Mr. Ferlauto. Let me just add one caveat to that. I think
John is right that there needs to be some flexibility, but
there also needs to be some very explicit disclosure about who
is responsible for risk, what committee is responsible for it,
what is their charter, what powers that they have, how they
will review risk, and that needs to be disclosed much more
heavily than it does right now.
Senator Corker. So you would moderate the bill in that way
and specify that it doesn't have to have a separate committee,
but that function has to take place within the board----
Mr. Ferlauto. And it needs to be disclosed to shareholders
in a very precise way, OK.
Senator Corker. So, since I am the last questioner----
Chairman Reed. Go ahead.
Senator Corker. ----let us go back to this issue of the
State thing again, which longer-term advocates of shareholder
rights have said, look, if we could just give shareholders the
ability to race to the top, as Senator Johanns, I think was
alluding to, I am not positive--I certainly asked the question
earlier in the same light--Mr. Castellani, how do you feel
about shareholders being able to say that you are not going to
be domiciled in whatever State you are in but you are going to
be in Texas because it gives great shareholder rights?
Mr. Castellani. Senator, if the majority of the
shareholders want to change the logo to pink and make me stand
on one leg, I change the logo to pink and stand on one leg. So
it really is what the majority of the shareholders. But I think
it is not a decision--I think we kid ourselves that this is a
decision that is based on what Mr. Icahn is advocating, which
is the ability of greater ease of change of control.
One of the reasons why Delaware is very attractive to
corporations is Delaware has an infrastructure, with all
deference to my colleague here, that is very efficient in
adjudicating issues between companies and shareholders, and
shareholders and shareholders, prior to annual meetings or
whenever they need to be adjudicated. Delaware is very, very
good. They have--what have they got, ten judges and a couple
hundred staff people that make decisions very, very quickly. So
it is not just the structure of the law that is attractive but
it is the ability of the State to implement its law and make
decisions when issues are in contention very quickly and very
efficiently.
Senator Corker. But while you are selling Delaware, and I
am sure the Chambers of Commerce up there like that----
Mr. Castellani. Well, let me give equal. New Jersey is also
very good. Ohio is very good----
[Laughter.]
Mr. Castellani. ----and I am sure----
Senator Corker. Their pension funds must invest in your
company.
Mr. Castellani. ----Tennessee is very good.
Senator Corker. But back to the issue of whether they are
good or not, and my guess is some of those are not so good that
you just mentioned, but giving the shareholders the ability to
do that is, in your opinion--and, by the way, by law? You have
no problem with that?
Mr. Castellani. Yes, I would. Why, again, prescribe for all
shareholders of all companies something that they already have
the right to do within the States where they are incorporated
if the States allow it.
Senator Corker. Does anybody strongly disagree with that?
Mr. Coates. Just so we are clear, currently, shareholders
do not have the right----
Mr. Castellani. Do not have the right.
Mr. Coates. ----do not have the right to force a
reincorporation over the objection of the board, and I actually
think for once I am on sort of the management side of the
Business Roundtable, at least if I heard his comment earlier. I
don't think that would be a good idea to introduce. It would be
more powerful and more disruptive on behalf of shareholders
than anything the SEC is proposing in the current environment.
Senator Corker. So you think that is a really bad idea?
Mr. Coates. Well, I just--I think it would require a great
deal of thought about how exactly it would be implemented, and
I think to think of it as somehow a weaker version of
shareholder proxy access is just descriptively a mistake. It
would be actually more empowering----
Senator Corker. No, I agree.
Mr. Coates. OK.
Senator Corker. It is the most empowering thing, I think,
that----
Mr. Castellani. And I want to make very clear that I
associate myself with those remarks, that that is--I can't
imagine what the benefit would be compared to the costs or the
disruption.
Senator Corker. Do you want to make a comment?
Mr. Ferlauto. I was just going to say, I think that is
true. I think the moderate form is establishing the disclosure
right for proxy access. But to go all the way to keep Governors
happy, if you will, is to create competition amongst the States
by fully empowering shareholders.
Ms. Yerger. As radical as the Council is, I have to tell
you, this is not an issue we have endorsed at this point, is
giving owners the right to reincorporate an entity. We are
studying it, but I think that it is a complex issue that I
would be very surprised the corporate community would support.
Mr. Ferlauto. This is the moderate version.
Mr. Verret. I would also offer that proposals and changes
of State of incorporation get introduced from time to time and
the results are always there is pretty low shareholder interest
in that.
Senator Corker. OK. Listen, I want to say that while I ask
numbers of questions, I am going to give the same disclosure as
the SEC. None of them necessarily represent my point of view.
It is just the best way to sort of understand what a very
diverse panel of six people think about an issue and I very
much appreciate all of your input today.
I hope that if we do anything on corporate governance, I
hope that it is modest and we realize that at the end of the
day, a lot of factors led to the failures that we have had
today, much of which, candidly, was generated out of this body
and those who came before. I hope that we don't create a
similar problem or another type of problem by over-legislating
how the private sector governs itself. But I thank you all for
your testimony.
Chairman Reed. Thank you, Senator Corker.
I want to thank all the witnesses. This has been a very
insightful panel, and I particularly thank you for the time and
effort you put into this. It was quite obvious from the
testimony and from your response to questions.
Let me say for the record, witnesses' complete written
testimony will become part of the hearing record and we are
happy to include supporting documentation for the record. The
record will remain open for 1 week, until August 5, 2009, for
Members to submit their own personal written statements or
additional questions for the witnesses. We ask that witnesses
respond to any written questions that are sent within 2 weeks
and note that the record will close after 6 weeks in order for
the hearing print to be prepared.
With that, I thank you again and thank my colleagues. The
hearing is adjourned.
[Whereupon, at 4:38 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN JACK REED
I want to welcome everyone, and thank all of our witnesses for
appearing today.
Today's hearing will focus on corporate boardrooms and try to help
us better understand the misaligned incentives that drove Wall Street
executives to take harmful risks with the life savings and retirement
nest eggs of the American people.
This Subcommittee has held several hearings in recent months to
focus on gaps in our financial regulatory system, including the largely
unregulated markets for over-the-counter derivatives, hedge funds and
other private investment pools. We have also examined problems that
resulted from regulators simply failing to use the authority they had,
such as our hearing in March that uncovered defective risk management
systems at major financial institutions.
But although regulators play a critical role in policing the
markets, they will always struggle to keep up with evolving and
cutting-edge industries. Today's hearing will examine how we can better
empower shareholders to hold corporate boards accountable for their
actions, and make sure that executive pay and other incentives are used
to help companies better focus on long-term performance goals over day-
to-day profits.
Wall Street executives who pursued reckless products and activities
they did not understand brought our financial system to its knees. Many
of the boards that were supposed to look out for shareholder interests
failed at this most basic of jobs. This hearing will help determine
where the corporate governance structure is strong, where it needs
improvement, and what role the Federal Government should play in this
effort.
I will ask our witnesses what the financial crisis has revealed
about current laws and regulations surrounding corporate governance,
including executive compensation, board composition, election of
directors and other proxy rules, and risk management. In particular, we
will discuss proposals to improve the quality of boards by increasing
shareholder input into board membership and requiring annual election
of, and majority voting for, each board member.
We will also discuss requiring ``say-on-pay,'' or shareholder
endorsements of executive compensation. We need to find ways to help
public companies align their compensation practices with long-term
shareholder value and, for financial institutions, overall firm safety
and soundness. We also need to ensure that compensation committee
members--who play key roles in setting executive pay--are appropriately
independent from the firm managers they are paying.
Other key proposals would require public companies to create risk
management committees on their boards, and separate the chair and CEO
positions to ensure that the CEO is held accountable by the board and
an independent chair.
I hope today's hearing will allow us to examine these and other
proposals, and take needed steps to promote corporate responsiveness to
the interests of shareholders. I welcome today's witnesses and look
forward to their testimony.
______
PREPARED STATEMENT OF MEREDITH B. CROSS
Director, Division of Corporation Finance, Securities and Exchange
Commission
July 29, 2009
Introduction
Good afternoon Chairman Reed, Ranking Member Bunning, and Members
of the Subcommittee. My name is Meredith Cross, and I am the Director
of the Division of Corporation Finance at the U.S. Securities and
Exchange Commission. I just rejoined the SEC staff in June of this year
after more than 10 years in private practice here in Washington. I
worked at the SEC for most of the 1990s, and I am delighted to be back
at the agency at this critical time in the regulation of our financial
markets. I am pleased to testify on behalf of the Commission today on
the topics of corporate governance and the agency's ongoing efforts to
assure that investors have the information they need to make educated
investment and voting decisions.
Investor confidence is critical to our securities markets. In the
context of the issues that the Subcommittee is discussing today,
investors need to feel confident that they have the information they
need to make educated decisions about their investments, including
whether to reelect or replace members of the board of directors. Good
corporate governance is essential to investor confidence in the
markets, and it cannot exist without transparency--that is, timely and
complete disclosure of material information. In responding to the
market crisis and erosion of investor confidence, the Commission has
identified and taken steps over the past months in a number of
significant areas where the Commission believes enhanced disclosure
standards and other rule changes may further address the concerns of
the investing public.
Shareholder Director Nominations
A fundamental concept underlying corporate law is that a company's
board of directors, while charged with managerial oversight of the
company, is accountable to its shareholders who have the power to elect
the board. Thus, boards are accountable to shareholders for their
decisions concerning, among other things, executive pay, and for their
oversight of the companies' management and operations, including the
risks that companies undertake. While shareholders have a right under
State corporate law to nominate candidates for a company's board of
directors, it can be costly to conduct a proxy contest, so this right
is only rarely exercised.
The Commission's proxy rules seek to enable the corporate proxy
process to function, as nearly as possible, as a replacement for in-
person participation at a meeting of shareholders. With the wide
dispersion of stock prevalent in today's markets, requiring actual in-
person participation at a shareholders' meeting is not a feasible way
for most shareholders to exercise their rights--including their rights
to nominate and elect directors. Two months ago, the Commission voted
to approve for notice and comment proposals that are designed to help
shareholders to more effectively exercise their State law right to
nominate directors. \1\
---------------------------------------------------------------------------
\1\ ``Facilitating Shareholder Director Nominations'', Securities
Exchange Act Release No. 34-60089 (June 10, 2009). The Commission's
vote was 3-2 in favor of the proposal, with Chairman Schapiro and
Commissioners Walter and Aguilar voting to approve the staff's
recommendation to propose rules, and Commissioners Casey and Paredes
voting not to approve the staff's recommendation. For the
Commissioners' statements regarding the proposal at the Commission
meeting at which the proposal was considered, see http://www.sec.gov/
news/speech.shtml#chair.
---------------------------------------------------------------------------
Under the proposals, shareholders who otherwise have the right to
nominate directors at a shareholder meeting would, subject to certain
conditions, be able to have a limited number of nominees included in
the company proxy materials that are sent to all shareholders whose
votes are being solicited. To be eligible to have a nominee or nominees
included in a company's proxy materials, a shareholder would have to
meet certain security ownership requirements and other specified
criteria, provide certifications about the shareholder's intent, and
file a notice with the Commission of its intent to nominate a
candidate. The notice would include specified disclosure about the
nominating shareholder and the nominee for inclusion in the company's
proxy materials. This aspect of the proposals is designed to provide
important information to all shareholders about qualifying shareholder
board nominees so that shareholders can make a more informed voting
decision.
To further facilitate shareholder involvement in the director
nomination process, the proposals also include amendments to Rule 14a-8
under the Exchange Act, which currently allows a company to exclude
from its proxy materials a shareholder proposal that relates to a
nomination or an election for membership on the company's board of
directors or a procedure for such nomination or election. This so-
called ``election exclusion'' can prevent a shareholder from including
in a company's proxy materials a shareholder proposal that would amend,
or that requests an amendment to, a company's governing documents
regarding nomination procedures or disclosures related to shareholder
nominations. Under the proposed amendment to the shareholder proposal
rule, companies would be required to include such proposals in their
proxy materials, provided the other requirements of the rule are met.
The proposing release seeks comments from the public on the rule
proposals generally and also includes numerous specific questions. The
comment process is a critical component of every rule making, and one
that the Commission takes very seriously. We sincerely want to hear
from all interested parties and truly believe that the rule-making
process is better informed as a result of the comments that we receive.
Proxy Disclosure Enhancements
One of the key disclosure documents for shareholders in deciding
how to vote in the election of directors is the proxy statement. This
document, which includes information about the directors, certain board
practices, executive compensation, related party transactions, and
other matters, is a critical component of the U.S. corporate governance
landscape. The Commission, on July 1, voted to propose a series of rule
amendments that are designed to significantly improve proxy
disclosures, thereby enabling shareholders to make more informed voting
decisions. \2\
---------------------------------------------------------------------------
\2\ ``Proxy Disclosure and Solicitation Enhancements,'' Securities
Exchange Act Release No.34-60280 (July 10, 2009).
---------------------------------------------------------------------------
One area that has garnered significant public attention and can
drive investors' investment and voting decisions is executive
compensation. The Commission's existing disclosure rules are designed
to elicit comprehensive and detailed information about all elements of
a company's compensation practices and procedures with respect to its
most senior executives. This information includes a ``Compensation,
Discussion and Analysis''; detailed tables followed by related
narrative disclosure; and a report from the Compensation Committee.
Based on this information, investors can form opinions about a
company's executive compensation policies, including whether the board
of directors has acted appropriately in setting incentives and rewards
for management.
Today, if material, a company must discuss the risk considerations
of its compensation policies and decisions with respect to its ``named
executive officers.'' (``Named executive officers'' generally include
the chief executive officer, chief financial officer, and next three
highest paid officers.) Some have argued, however, that the recent
financial crisis has demonstrated that a company's compensation
practices beyond these five named executive officers can have a
dramatic impact on its risk profile; the manner in which some trading
arms of financial institutions have been compensated would be an
example. Therefore, the Commission has proposed requiring disclosure
about how the company incentivizes its employees--beyond the named
executive officers--if its compensation policies may result in material
risks to the company. This disclosure is intended to enable investors
to gauge whether the company's compensation policies create appropriate
incentives for its employees, as opposed to creating incentives for
employees to act in a way that creates risks not aligned with the risk
objectives of the company.
The Commission's recent proxy enhancement proposals also would
require expanded information about the qualifications of directors and
director candidates, about the board's leadership structure and role in
risk management, and about potential conflicts of interests of
compensation consultants. The proposals also would improve the
reporting of annual stock and option awards to company executives and
directors, and would require quicker reporting of shareholder vote
results. The Commission believes that all of this information would
enable shareholders to more intelligently exercise their proxy vote,
thereby further enhancing corporate accountability.
Broker Discretionary Voting
Also on July 1, the Commission approved changes to New York Stock
Exchange Rule 452, which governs broker discretionary voting, to
prohibit brokers from voting shares held in street name in director
elections unless they have received specific voting instructions from
their customers. \3\ NYSE Rule 452 generally allows brokers to vote
such shares on behalf of their customers in uncontested director
elections, as such elections are currently deemed to be ``routine;''
under the revised rule, such elections will no longer be deemed to be
routine. This amendment, which the NYSE approved at least in part based
on recommendations from the NYSE's Proxy Working Group, will become
effective on January 1, 2010.
---------------------------------------------------------------------------
\3\ ``Order Approving Proposed Rule Change, as modified by
Amendment No. 4, to Amend NYSE Rule 452 and Corresponding Listed
Company Manual Section 402.08 to Eliminate Broker Discretionary Voting
for the Election of Directors, Except for Companies Registered Under
the Investment Company Act of 1940, and to Codify Two Previously
Published Interpretations that Do Not Permit Broker Discretionary
Voting for Material Amendments to Investment Advisory Contracts with an
Investment Company,'' Securities Exchange Act Release No. 34-60215
(July 1, 2009). The Commission's vote was 3-2 in favor of the proposal,
with Chairman Schapiro and Commissioners Walter and Aguilar voting to
approve the rule change, and Commissioners Casey and Paredes voting not
to approve the rule change. For the Commissioners' statements regarding
the proposal at the Commission meeting at which the rule change was
approved, see http://www.sec.gov/news/speech.shtml#chair.
---------------------------------------------------------------------------
The Commission also has asked that the staff undertake--this year--
a comprehensive review of other potential improvements to the proxy
voting system and rules governing shareholder communications, including
exploring whether issuers should have better means to communicate with
street name holders. With over 800 billion shares being voted annually
at over 7,000 company meetings, it is imperative that our proxy voting
process work well, beginning with the quality of disclosure and
continuing through to the integrity of the vote results.
Say-on-Pay for TARP Companies
Also on July 1, the Commission proposed amendments to the proxy
rules to set out the requirements for a ``say-on-pay'' vote at public
companies that that have received (and not repaid) financial assistance
under the Troubled Asset Relief Program. \4\ Under the Emergency
Economic Stabilization Act of 2009, these companies are required to
permit an annual advisory shareholder vote on executive compensation.
Consistent with the EESA, the Commission's proposals would require
public companies that are TARP recipients to provide a separate
shareholder vote on executive compensation in proxy solicitations
during the period in which any obligation arising from financial
assistance provided under the TARP remains outstanding. These proposals
are intended to clarify what is necessary under the Commission's proxy
rules to comply with the EESA vote requirement and help to assure that
TARP recipients provide useful information to shareholders about the
nature of the required advisory vote on executive compensation.
---------------------------------------------------------------------------
\4\ ``Shareholder Approval of Executive Compensation of TARP
Recipients,'' Securities Exchange Act Release No. 34-60218 (July 1,
2009).
---------------------------------------------------------------------------
Conclusion
As governance and compensation practices continue to evolve, the
Commission will remain vigilant in seeking to assure that our
disclosure rules provide investors with the information they need to
make informed investment and voting decisions. We know that there also
is a great deal of thought and work outside the agency regarding
corporate governance and executive compensation best practices, and we
stand ready to lend whatever assistance we can in those efforts.
Thank you again for inviting me to appear before you today and for
the Subcommittee's support of the agency in its efforts at this
critical time for the Nation's investors. I would be happy to answer
any questions you may have.
______
PREPARED STATEMENT OF JOHN C. COATES IV
John F. Cogan, Jr., Professor of Law and Economics, Harvard Law School
July 29, 2009
Introduction
Chairman Reed, Ranking Member Bunning, and Members of the
Subcommittee, I want to thank you for inviting me to testify. Effective
corporate governance is a crucial foundation for economic growth, and I
am honored to have been asked to participate.
A. Are There Any General Lessons for Corporate Governance from the
Financial Crisis?
Some have described the ongoing financial crisis as reflecting
poorly on U.S. corporate governance, as with the accounting scandals
and stock market bubbles of the late 1990s and early 2000s that led to
the Sarbanes-Oxley Act. Unlike those episodes, however, the ongoing
financial crisis has not exposed new and widespread problems with the
basic governance of most U.S. publicly held corporations. Outside the
financial and automotive sectors, most companies have suffered only as
a result of the crisis, and did not contribute to or cause it. Stock
prices have fallen across the board, but most price declines have more
to do with the challenges facing the real economy, and the spillovers
from the financial sector on companies in need of new capital, and
little to do with any general problem with corporate governance. As a
result, we have learned relatively little about many long-standing
concerns and debates surrounding the governance of publicly held
corporations--and there are few if any easy lessons that can be drawn
from the crisis for corporate governance generally.
I do not mean to minimize those concerns and debates, or suggest
lawmakers should remain passive in the field of corporate governance.
To the contrary, the crisis makes reform more important and urgent than
ever, because well-governed companies recover and adapt more readily
than poorly governed firms. But the best reform path will need to
attend to differences between governance across industries, and ways
that corporate governance interacts with industry-based regulation--and
in particular, financial industry regulation--if legal changes are not
to make things worse, rather than better. Governance flaws at Citigroup
differed dramatically from governance flaws at GM, and attempts to fix
the problems at firms like GM through laws directed at all public
companies could make things worse at firms like Citigroup.
One important problem at financial firms was excessive risk-taking,
stemming from a so-called ``bonus culture'' of compensation practices
strongly linked to share prices. But the risks that financial firms
took on were harmful for the Nation as a whole because the financial
firms were so important (and complex) and existing resolution authority
so weak and poorly designed that those financial firms could not
generally be allowed to fail. As a result, in economic terms, financial
firms' compensation practices did not take into account the external
effects on taxpayers in the event of insolvency. In effect, financial
firms were allowed to gamble with taxpayer money. This would have been
true even if managers of those firms had been perfect stewards of
shareholder wealth. The suggestion of my colleagues Holger Spamann and
Lucian Bebchuk (2009)--praised by the New York Times editors earlier
this week--that financial firms be required to link compensation to
returns on their bonds as well as their common stocks reflects this
point. Shareholders are not the only important corporate constituency
to consider in setting corporate governance rules for banks.
At most public companies, the diagnosis has not been the same. If
anything, the conventional critique of the governance of nonfinancial
companies is that boards and managers have tended (from the shareholder
perspective) to be excessively resistant to change, and to have tied
executive compensation too weakly with performance. When commentators
attempt to link compensation at firms like AIG and claims about
excessive executive compensation at public companies generally, they
fail to acknowledge that most shareholders do not mind if executives
make an enormous amount of money, as long as shareholders also gain.
Efforts to increase shareholder power to encourage managers more
strongly to pursue shareholder wealth could--at financial firms--
undermine efforts by bank regulators to restrain risk-taking by those
same firms. The most important practical lesson of the financial crisis
is, then, this: whatever form general corporate governance reform
takes, careful thought should be given to exempting--or at least
allowing relevant financial regulatory authorities to exempt or
override--financial firms from those reforms.
B. Evidence on Policy Options
Turning from the general lessons of the financial crisis to some of
the specific governance reforms that have been discussed or proposed in
the last few years, it is important to bear in mind that corporate
governance is not rocket science--in fact, it is much more complicated
than rocket science. Corporations are in their simplest sense large
groups of people coordinating their activities for profit. Science has
a hard enough task tracking inert matter moving through space; it has a
harder time predicting the behavior of a single actual or typical
human; and it has the hardest time of all attempting to describe or
predict how large groups of people will act--if for no other reason
than researchers cannot experiment on large groups of people in
realistic settings. As a result, there are few consensus views among
researchers about any nontrivial topic in corporate governance, and
evidence tends to emerge slowly, is rarely uncontested, and is subject
to constant (and often dramatic reevaluation). As a result, everything
that you do in setting rules for corporate governance should keep the
fragility of the evidence in mind: set rules that can be changed by
delegating to regulatory agencies; direct those agencies to review and
reassess their own rules regularly; and provide ``opt outs'' and
``sunsets'' to governance mandates that are expected to last
indefinitely, as at many corporations.
As one example, to my knowledge, there is no reliable large-scale
empirical evidence--good or bad--on the effects of shareholder access
to a company's proxy statement, along the lines proposed by the SEC and
mandated by S. 1074, H.R. 3269 and H.R. 2861, because there has no been
no significant observed variation in such a governance system within
any modern developed economy. This does not mean that there is no
information relevant to evaluating how such a system would operate in
practice, or that there is no basis on which such a system could be
recommended or adopted. Rather, the absence of observed variation means
that there is no general body of data that is capable of revealing
whether such a system would consistently have good or bad effects on
shareholder welfare--and no such data will exist unless and until a
large number of companies voluntarily adopt such a system or are
required to by law. That is generally true of many corporate governance
proposals, and to require such data before adopting rule changes would
effectively freeze laws governing corporate governance in place
indefinitely, preventing further inquiry or development of evidence.
Nonetheless, there are some corporate governance topics about which
evidence is better than others. Here I set out what is necessarily an
abbreviated summary of the evidence on three topics addressed in one or
more bills pending in the current Congress, including the Shareholder
Bill of Rights Act of 2009 (S. 1074): (a) ``say-on-pay,'' (b) mandatory
separation of the chairman and CEO positions, and (c) mandatory annual
board elections.
a. Say-on-Pay
The proposed requirement that shareholders be given an advisory
vote on executive pay has the advantage that it is very similar to a
requirement adopted in another jurisdiction (the United Kingdom (U.K.))
that has capital markets and laws that are otherwise similar to those
applicable in the United States. \1\ This fact enables a research
approach that is otherwise unavailable: a before-and-after test of
board and shareholder responses, compensation practices, stock market
reactions and shareholder returns, and other items of interest
surrounding the adoption of ``say-on-pay'' in the U.K.. Different
researchers have conducted several investigations of this kind and the
results published at least informally. Those researchers report that
``say-on-pay's'' adoption in the U.K.:
---------------------------------------------------------------------------
\1\ Say-on-Pay legislation has also been adopted in Australia,
Norway, Sweden, and the Netherlands. Deane (2007).
improved the link between executive pay and corporate
---------------------------------------------------------------------------
performance (Ferri and Maber 2007);
led firms (both before and after relatively negative
shareholder votes) to adopt better pay practices (id.);
led activist shareholders to target firms with weak pay-
performance links and those with higher-than-expected executive
compensation levels (id.; Alissa 2009);
did not reduce or slow the overall increase in executive
compensation levels (Ferri and Maber 2007; Gordon 2008).
Together, these findings suggest that ``say-on-pay'' legislation would
have a positive impact on corporate governance in the U.S. While the
two legal contexts are not identical, there is no evidence in the
existing literature to suggest that the differences would turn what
would be a good idea in the U.K. into a bad one in the U.S.
Researchers have also exploited the introduction of earlier ``say-
on-pay'' legislation in the U.S. to examine stock price reactions to
the prospect of such a governance reform. Consistent with the U.K.
findings, they report that stock investors appear to have viewed the
proposed legislation as good for firms with higher-than-typical
executive compensation, firms with weak pay-performance links, and
firms with weak corporate governance measured in various ways (Cai and
Walkling 2009). \2\ They also report data showing that the market
reacted positively at most sample firms to the proposed legislation.
The same researchers also report that shareholder-sponsored efforts to
introduce ``say-on-pay'' rules at individual firms--particularly when
sponsored by unions with low stock holdings in the targeted firms--were
not well-received by the stock market, in part because they were not
directed at firms with higher-than-typical executive compensation or
firms with weak pay-performance links, but instead simply at companies
that happen to be large. The researchers suggest that their findings
show that one-size-fits-all ``say-on-pay'' legislation may be harmful,
but this implication does not in fact follow from their findings. If
anything, the U.K. evidence summarized above suggests that general
``say-on-pay'' legislation will weaken the ability of special interest
shareholder activists to exploit executive compensation as an issue,
and will lower the costs of the broad run of shareholders to use their
advisory votes on pay to target firms that are most in need of pressure
to improve pay practices.
---------------------------------------------------------------------------
\2\ The authors report that firms with the very weakest corporate
governance ratings did not exhibit negative stock price reactions to
steps toward to the passage of ``say-on-pay'' legislation, and
plausibly suggest that this may be because such firms may not respond
to advisory shareholder votes.
---------------------------------------------------------------------------
b. Mandatory Separation of Chairman and CEO Positions
In comparison to research on ``say-on-pay'' rules, the evidence on
the proposal to mandate the separation of the chair and the CEO of
public companies is more extensive and considerably more mixed. At
least 34 separate studies of the differences in the performance of
companies with split vs. unified chair/CEO positions have been
conducted over the last 20 years, including two ``meta-studies.''
Dalton et al. (1998) (reviewing 31 studies of board leadership
structure and finding ``little evidence of systematic governance
structure/financial performance relationships'') and Rhoades et al.
(2001) (meta-analysis of 22 independent samples across 5,271 companies
indicates that independent leadership structure has a significant
impact on performance, but this impact varies with context). The only
clear lesson from these studies is that there has been no long-term
trend or convergence on a split chair/CEO structure, and that variation
in board leadership structure has persisted for decades, even in the
U.K., where a split chair/CEO structure is the norm.
One study provides evidence consistent with one explanation of the
overall lack of strong findings: optimal board structures may vary by
firm size, with smaller firms benefiting from a unified chair/CEO
position, with the clarity of leadership that structure provides, and
larger firms benefiting from the extra monitoring that an independent
chair may provide given the greater risk of ``agency costs'' at large
companies. Palmon et al. (2002) (finding positive stock price reactions
for small firms that switch from split to unified chair/CEO structure,
and negative reactions for large firms). If valid, this explanation
would suggest that it would be a good idea for any legislation on board
leadership to (a) limit any mandate to the largest firms and (b) permit
even those firms to ``opt out'' of the requirement through periodic
shareholder votes (e.g., once every 5 years).
c. Mandatory Annual Board Elections
The evidence on the last legislative proposal I will address--
mandatory annual board elections (i.e., a ban on staggered boards)--is
thinner and at first glance more compelling than that on board
leadership structure, but on close review is just as mixed. There have
been at least two studies that focus on the specific relationship
between annual board elections and firm value (Bebchuk and Cohen 2005;
Faleye 2007), and a number of other papers that include annual board
elections in studying the relationship between broader governance
indices and firm value more generally (e.g., Gompers et al., 2003;
Cremers and Ferrell 2009). Most (but not all \3\) conclude that annual
board elections (either on their own or in combination with other
governance practices) are associated with higher firm value, as
measured by the ratio of firms' stock prices to their book values. \4\
The governance-valuation studies, however, generally suffer from a
well-known ``endogeneity'' problem--that is, it is difficult (and given
data limitations, sometimes impossible) to know whether annual
elections improve firm value, or firm value determines whether a
company chooses to hold annual elections. While there are statistical
techniques that can address this issue, none of the studies to date
have presented compelling evidence that annual elections lead to better
performance, at least in the last 20 years, during which time public
companies rarely switched from annual to staggered elections. Moreover,
the longer a given study of this type has been available for others to
attempt to replicate, the more fragile the findings have appeared to
be, suggesting that the bottom-line conclusions of more recent studies
may not hold up in the face of continued research.
---------------------------------------------------------------------------
\3\ Ahn, Goyal, and Shrestha (2009) (finding that annual board
elections reduces pay-performance sensitivity and investment efficiency
in firms with low monitoring costs, while having the opposite effects
on firms with high monitoring costs).
\4\ Some suggest that the difference in firm value follows from
the fact that annual board elections make hostile takeovers easier. See
Bebchuk, Cohen, and Ferrell 2009. See also Bebchuk, Coates, and
Subramanian 2001 (finding that staggered board elections reduce hostile
bid completion rates, conditional on hostile bids being made).
---------------------------------------------------------------------------
Evidence on annual elections is further complicated by the fact
that companies that ``go public'' for the first time continue to adopt
staggered board elections at high rates, as late as 2007. \5\ Since the
evidence regarding the purported ability of staggered boards to improve
firm value has been known for some time, and since shareholders have
the ability to adjust the prices they pay for newly issued IPO shares
to reflect governance practices, the fact of continued adoption of
staggered board elections prior to IPOs suggests that there may be a
social advantage to permitting these structures, at least when adopted
before a company goes public. Other researchers have made a similar
point about ``dual class'' capital structures, which give low or no
votes to public investors, while letting founders or their family
members retain high vote stock. SEC rules and stock exchange listing
standards have for a long time permitted such structures to be adopted
in the U.S. only prior to a company going public, and not once a
company has gone public. Such structures, as with staggered board
elections, have long been thought to reduce firm value, measured by
reference to public stock prices. Yet, as with staggered boards, some
companies continue to adopt dual class structures--and some have done
quite well by their shareholders (e.g., Google Inc.--still up over 300
percent since its IPO despite the recent market meltdown).
---------------------------------------------------------------------------
\5\ See data available at SharkRepellent.Net, which reported that
despite general declines in takeover defenses at public companies in
the 2000s, defenses at firms going public continued to increase, with
almost \3/4\s of newly public companies adopting staggered boards. See
also Coates 2001.
---------------------------------------------------------------------------
The best explanation offered by academic researchers to explain the
continued use of dual class structures and staggered board elections is
that they provide founders assurance of continued control, which they
value more than the stock price of their companies might reflect. Such
private value may arise because of particular attachments the founders
have toward the companies they have helped build from scratch, or
because they hope to pass control of their companies to their children,
or because they have developed ``firm-specific capital'' that they
would lose if the company were acquired (and which would be hard to
value by outsiders). Some evidence has been developed consistent with
these explanations (see Coates 2004, reviewing prior research). This
evidence is worth considering not only because dual class structures
are analogous to staggered board elections--and interfere with hostile
takeovers and shareholder voting rights even more than do staggered
board elections--but also because any to mandate annual board elections
would also require a ban on dual class structures, or else it would
simply push companies to adopt the more restrictive dual class
structure in lieu of staggered boards.
C. Recommendations
My recommendations flow from my review of the implications of the
financial crisis and my review of evidence above:
First, any corporate governance reform that attempts to shift power
from boards or managers to shareholders should either not include
financial firms, or should include a clear delegation of authority to
financial regulators to exempt financial firms from these power shifts
by regulation. Simply directing financial regulators to regulate the
same governance practices (as in H.R. 3269) may not suffice to prevent
shareholder pressure from encouraging firms to craft ways around those
regulations. It would be better more generally to moderate the pressure
of shareholders on financial firms to maximize short-term profit at the
potential expense of the financial system and taxpayers.
Second, ``say-on-pay'' legislation is likely to be a good idea. By
enabling shareholders across the board to provide feedback in the form
of advisory votes to boards on executive compensation, such a
requirement would be likely to increase board scrutiny on one element
of corporate governance that has the greatest potential for improving
incentives and firm performance in the long run. At the same time, it
should be recognized that ``say-on-pay'' is not likely to achieve
general distributive goals--wealthy CEOs will continue to earn outsize
compensation, as long as their shareholders benefit. If the goal of
Congress is to reduce wealth or income disparities, ``say-on-pay'' is
not the right mechanism, and executive compensation is only a
relatively minor part of the picture. For that reason, efforts to use
corporate governance practices--which after all only affect a subset of
all U.S. companies, those that have dispersed shareholders--to force a
linkage between CEO and employee pay seem to me misguided. It would be
better to address pay disparities in the tax code.
Third, while mandating a split between the chair and the CEO is not
clearly a good idea for all public companies, it may well be a good
idea for larger companies. Because shareholders of those same companies
may find it difficult to initiate such a change, given the difficulties
of collective action, a legislative change requiring a split leadership
structure but permitting shareholder-approved opt outs may improve
governance for many companies while imposing relatively minor costs on
companies generally. Requiring that companies give shareholders a vote
on such a choice episodically (e.g., every 5 years) would also be a way
to help solve shareholders' inevitable collective action problems
without forcing a one-size-fits-all solution on companies generally.
Fourth, mandating that all public companies hold annual elections
for all directors is not clearly supported by evidence or theory. It
perhaps bears mentioning that other important institutions (the SEC,
the Fed, the Senate) permit staggered elections for good reason, and
that any rule mandating annual elections would ride roughshod over
State law--in Massachusetts, for example, companies are required to
have staggered board elections unless they affirmatively opt out of the
requirement. In prior writing, I have suggested it be left to the
courts to review director conduct with a more skeptical eye at
companies that adopted staggered boards prior to the development of the
poison pill (Bebchuk, Coates, and Subramanian 2001), and I have also
suggested elsewhere reasons to consider ``re-opening'' corporate
governance practices put in place long ago (Coates 2004). Both
approaches would be better than an across-the-board annual election
mandate, which would be likely to lead new companies to adopt even more
draconian governance practices without any clear net benefit.
Finally, precisely because there is no good evidence on the
potential effects of shareholder proxy access, it would seem to be the
best course to move cautiously in adopting rules permitting or
requiring such access. For that reason, the most that would seem
warranted for a hard-to-change statute to achieve is to mandate that
the SEC adopt a rule providing for such access, and thereby to clarify
the SEC's authority to do so. Any shareholder access rule will need to
address not only the length of the holding period and ownership
threshold required to obtain such access, the ability of shareholders
to aggregate holdings to obtain eligibility, rules for independence of
nominees and shareholders using the rule, and the availability of the
rule to those seeking control or influence of a company. Efforts to
specify rules for such access at a greater level of detail will
probably miss the mark, and be difficult to correct if experience shows
that the access has either provided too much or too little access to
accomplish the presumed goal of enhancing shareholder welfare.
References
Seoungpil Ahn, Vidhan K. Goyal, and Keshab Shrestha, ``The Differential
Effects of Classified Boards on Firm Value'', Working Paper (June
27, 2009).
Walid M. Alissa, ``Boards' Response to Shareholders' Dissatisfaction:
The Case of Shareholders' Say-on-Pay in the U.K.'', Working Paper
(2009).
Lucian A. Bebchuk, John C. Coates, and Guhan Subramanian, ``The
Powerful Antitakeover Force of Staggered Boards: Theory, Evidence
and Policy,'' 54, Stanford Law Review 887 (2002), available at
ssrn.com/abstract_id=304388.
Lucian A. Bebchuk, Alma Cohen, and Allen Ferrell, ``What Matters in
Corporate Governance?'', Review of Financial Studies 22, 783
(2009).
Lucian A. Bebchuk and Holger Spamann, ``Regulating Bankers' Pay'',
Working Paper, forthcoming Georgetown Law Journal (2009).
Jay Cai and Ralph A. Walkling, ``Shareholders' Say-on-Pay: Does It
Create Value?'', Working Paper (2009).
John C. Coates IV, ``Explaining Variation in Takeover Defenses: Blame
the Lawyers'', 89, California Law Review 1376 (2001).
John C. Coates IV, ``Ownership, Takeovers and EU Law: How Contestable
Should EU Corporations Be?'', In Reforming Company and Takeover Law
in Europe, Guido Ferrarini, Klaus J. Hopt, Jaap Winter, and Eddy
Wymeersch, eds., Oxford University Press, 2004, available at
ssrn.com/abstract_id=424720.
Martijn Cremers and Allen Ferrell, ``Thirty Years of Corporate
Governance: Determinants and Equity Prices'', Working Paper (2009).
Dan R. Dalton, Catherine M. Daily, Alan E. Ellstrand, and Jonathan L.
Johnson, ``Meta-Analytic Reviews of Board Composition, Leadership
Structure and Financial Performance'', 19, Str. Mgt. J. 269 (1998).
S. Deane, ``Say-on-Pay: Results From Overseas'', The Corporate Board,
July/August 2007, 11-18 (2007).
Olubunmi Faleye, ``Classified Boards, Firm Value, and Managerial
Entrenchment'', Journal of Financial Economics, 83, 501-529 (2007).
Fabrizio Ferri and David Maber, ``Say-on-Pay Vote and CEO Compensation:
Evidence From the U.K.'', Working Paper (2007).
Paul Gompers, J. Ishii, and A. Metrick, ``Corporate Governance and
Equity Prices'', Quarterly Journal of Economics 118, 107-155
(2003).
Jeffrey N. Gordon, `` `Say-on-Pay': Cautionary Notes on the U.K.
Experience and the Case for Shareholder Opt-In'', Working Paper
(2008).
O. Palmon and J.K. Wald, ``Are Two Heads Better Than One? The Impact of
Changes in Management Structure on Performance by Firm Size'', 8,
J. Corp. Fin. 213 (2002).
D.L. Rhoades, P.L. Rechner, and C. Sundaramurthy, ``A Meta-Analysis of
Board Leadership Structure and Financial Performance: Are `Two
Heads Better Than One'?'', 9, Corp. Gov.: An Int'l Rev. 311 (2001).
______
PREPARED STATEMENT OF ANN YERGER
Executive Director, Council of Institutional Investors
July 29, 2009
Chairman Reed, Ranking Member Bunning, and Members of the
Subcommittee: Good morning. I am Ann Yerger, Executive Director, of the
Council of Institutional Investors (Council). I am pleased to appear
before you today on behalf of the Council.
My testimony includes a brief overview of the Council followed by a
discussion of our views on the following issues that you informed me
were the basis for this important and timely hearing:
What weaknesses has the financial crisis revealed about
executive compensation, board composition, proxy rules, or
other corporate governance issues?
What key legislative and regulatory changes should be
considered to ensure shareholders are adequately protected and
appropriate incentives exist for optimal long-term performance
at companies?
What information exists about the potential impact of
various approaches to improving corporate governance
regulation?
The Council
Founded in 1985 the Council is a nonpartisan, not-for-profit
association of public, labor and corporate employee benefit funds with
assets exceeding $3 trillion. \1\ Today the organization is a leading
advocate for improving corporate governance standards for U.S.
companies and strengthening investor rights.
---------------------------------------------------------------------------
\1\ See Attachment 1.
---------------------------------------------------------------------------
Council members are responsible for investing and safeguarding
assets used to fund retirement benefits of millions of participants and
beneficiaries throughout the U.S. They have a significant commitment to
the U.S. capital markets, with the average Council member investing
approximately 60 percent of its entire portfolio in U.S. stocks and
bonds. \2\
---------------------------------------------------------------------------
\2\ Council of Institutional Investors, Asset Allocation Survey
2008 at 2, http://www.cii.org/UserFiles/file/resource%20center/
publications/2008%20Asset%20Allocation%20Survey.pdf.
---------------------------------------------------------------------------
They are also long-term, patient investors due to their investment
horizons and their heavy commitment to passive investment strategies.
Because these passive strategies restrict Council members from
exercising the ``Wall Street walk'' and selling their shares when they
are dissatisfied, corporate governance issues are of great interest to
our members.
Council members have been deeply impacted by the financial crisis.
As a result, they have a vested interest in ensuring that the gaps and
shortcomings revealed by the financial crisis are repaired.
What weaknesses has the financial crisis revealed about executive
compensation, board composition, proxy rules, or other
corporate governance issues?
The Council believes the financial crisis has exposed some very
significant weaknesses in the regulation and oversight of the U.S.
capital markets. Gaps in regulation, inadequate resources at existing
regulators and failures of regulatory will were key contributors. But
so were failures in the corporate boardroom.
Council members, U.S. citizens, and investors around the globe,
have paid the price for these failures. Not only have they suffered
trillions of dollars in investments losses, they have also lost
confidence in the integrity of our markets and in the effectiveness of
board oversight of corporate management.
A comprehensive review and a meaningful restructuring of the U.S.
financial regulatory model are necessary steps toward restoring
investor confidence in our markets and protecting against a repeat of
these failures. But regulatory reform alone is insufficient, because
vigorous securities regulation on its own cannot solve many of the
issues that led to the current crisis. The Council believes that many
corporate governance failures contributed to this financial crisis. And
as a result, the Council believes corporate governance improvements are
a critical component of the necessary package of reforms.
In some cases corporate boards failed shareowners. Some failed to
adequately understand, monitor and oversee enterprise risk. Some failed
to include directors with the necessary blend of independence,
competencies, and experiences to adequately oversee management and
corporate strategy. And far too many corporate boards structured and
approved executive compensation programs that motivated excessive risk
taking and yielded outsized rewards--with little to no downside risk--
for short-term results.
Current rules and regulations also failed shareowners. Today,
shareowners around the world--including in countries with far less
developed capital markets than the U.S.--enjoy basic rights that
shareowners of U.S. companies are denied. Rights such as requiring
directors to be elected by majority vote, giving owners advisory votes
on executive pay, and providing owners modest vehicles to access
management proxy cards to nominate directors are noticeably absent in
much of corporate America. Their nonexistence weakens the ability of
shareowners to oversee corporate directors--their elected
representatives--and hold directors accountable.
The U.S. has long been recognized as a leader when it comes to
investor protection, market transparency, and oversight. But the U.S.
has fallen short when it comes to corporate governance issues. The
Council believes that corporate governance enhancements are a long
overdue and essential component of the bold reforms required to restore
confidence in the integrity of the U.S. capital markets.
What key legislative and regulatory changes should be considered to
ensure shareholders are adequately protected and appropriate
incentives exist for optimal long-term performance at
companies?
The Council believes a number of key corporate governance reforms
are essential to providing meaningful investor oversight of management
and boards and restoring investor confidence in our markets. Such
measures would address many of the problems that led to the current
crisis, and more importantly, empower shareowners to anticipate and
address unforeseen future risks. These measures, rather than
facilitating investors seeking short-term gains, are consistent with
enhancing long-term shareowner value.
More specifically, the governance improvements that the Council
believes would have the greatest impact and, therefore, should be
contained in any financial markets regulatory reform legislation
include:
Majority Voting for Directors: Directors in uncontested
elections should be elected by a majority of the votes cast.
Shareowner Access to the Proxy: A long-term investor or
group of long-term investors should have access to management
proxy materials to nominate directors.
Executive Compensation Reforms: Recommended reforms include
advisory shareowner vote on executive pay, independent
compensation advisers, stronger clawback provisions and
enhanced disclosure requirements.
Independent Board Chair: Corporate boards should be chaired
by an independent director. \3\
---------------------------------------------------------------------------
\3\ See Attachments 2 and 3.
---------------------------------------------------------------------------
Majority Voting for Directors
Directors are the cornerstone of the U.S. corporate governance
model. And while the primary powers of shareowners--aside from buying
and selling their shares--are to elect and remove directors, U.S.
shareowners have few tools to exercise these critical and most basic
rights.
The Council believes the accountability of directors at most U.S.
companies is weakened by the fact that shareowners do not have a
meaningful vote in director elections. Under most State laws the
default standard for uncontested director elections is a plurality
vote, which means that a director is elected in an uncontested
situation even if a majority of the shares are withheld from the
nominee.
The Council has long believed that a plurality standard for the
election of directors is inherently unfair and undemocratic and that a
majority vote standard is the appropriate one. The concept of majority
voting is difficult to contest--especially in this country. And today
majority voting is endorsed by all types of governance experts,
including law firms advising companies and corporate boards.
Majority voting makes directors more accountable to shareowners by
giving meaning to the vote for directors and eliminating the current
``rubber stamp'' process. The benefits of this change are many: it
democratizes the corporate electoral process; it puts real voting power
in hands of investors; and it results in minimal disruption to
corporate affairs--it simply makes board's representative of
shareowners.
The corporate law community has taken some small steps toward
majority voting. In 2006 the ABA Committee on Corporate Laws approved
amendments to the Model Business Corporation Act to accommodate
majority voting for directors, and lawmakers in Delaware, where most
U.S. companies are incorporated, amended the State's corporation law to
facilitate majority voting in director elections. But in both cases
they stopped short of switching the default standard from plurality to
majority.
Since 2006 some companies have volunteered to adopt majority voting
standards, but in many cases they have only done so when pressured by
shareowners forced to spend tremendous amounts of time and money on
company-by-company campaigns to advance majority voting.
To date, larger companies have been receptive to adopting majority
voting standards. Plurality voting is the standard at less than a third
of the companies in the S&P 500. However, plurality voting is still
very common among the smaller companies included in the Russell 1000
and 3000 indices. Over half (54.5 percent) of the companies in the
Russell 1000, and nearly three-quarters (74.9 percent) of the companies
in the Russell 3000, still use a straight plurality voting standard for
director elections. \4\ Statistics are not available for the thousands
of additional companies not included in these indices; however, the
Council believes most do not have majority voting standards.
---------------------------------------------------------------------------
\4\ Annalisa Barrett and Beth Young, ``Majority Voting for
Director Elections'', Directorship 1 (Dec. 16, 2008), http://
www.directorship.com/contentmgr/showdetails.php/id/33732/page/1.
---------------------------------------------------------------------------
Plurality voting is a fundamental flaw in the U.S. corporate
governance system. It is time to move the default standard to majority
voting. Given the failure by the States, particularly Delaware, to take
the lead on this reform, the Council believes the time has come for the
U.S. Congress to legislate this important and very basic shareowner
right.
Shareowner Access to the Proxy
Nearly 70 years have passed since the Securities and Exchange
Commission (``SEC'' or ``Commission'') first considered whether
shareowners should be able to include director candidates on
management's proxy card. This reform, which has been studied and
considered on and off for decades, is long overdue. Its adoption would
be one of the most significant and important investor reforms by any
regulatory or legislative body in decades. The Council applauds the SEC
for its leadership on this important issue.
The financial crisis highlighted a longstanding concern--some
directors are not doing the jobs expected by their employers, the
shareowners. Compounding the problem is the fact that in too many cases
the director nomination process is flawed, largely due to limitations
imposed by companies and the securities laws.
Some boards are dominated by the CEO, who plays the key role in
selecting and nominating directors. All-independent nominating
committees ostensibly address this concern, but problems persist. Some
companies don't have nominating committees, others won't accept
shareowner nominations for directors, and Council members' sense is
that shareowner-suggested candidates--whether or not submitted to all-
independent nominating committees--are rarely given serious
consideration.
Shareowners can now only ensure that their candidates get full
consideration by launching an expensive and complicated proxy fight--an
unworkable alternative for most investors, particularly fiduciaries who
must determine whether the very significant costs of a proxy contest
are in the best interests of plan participants and beneficiaries. While
companies can freely tap company coffers to fund their campaigns for
board-recommended candidates, shareowners must spend their own money to
finance their efforts. And companies often erect various obstacles,
including expensive litigation, to thwart investors running proxy
fights for board seats.
The Council believes reasonable access to company proxy cards for
long-term shareowners would address some of these problems. We believe
such access would substantially contribute to the health of the U.S.
corporate governance model and U.S. corporations by making boards more
responsive to shareowners, more thoughtful about whom they nominate to
serve as directors and more vigilant about their oversight
responsibilities.
As such, Council members approved the following policy endorsing
shareowner access to the proxy:
Companies should provide access to management proxy materials
for a long-term investor or group of long-term investors owning
in aggregate at least three percent of a company's voting
stock, to nominate less than a majority of the directors.
Eligible investors must have owned the stock for at least 2
years. Company proxy materials and related mailings should
provide equal space and equal treatment of nominations by
qualifying investors.
To allow for informed voting decisions, it is essential that
investors have full and accurate information about access
mechanism users and their director nominees. Therefore,
shareowners nominating director candidates under an access
mechanism should adhere to the same SEC rules governing
disclosure requirements and prohibitions on false and
misleading statements that currently apply to proxy contests
for board seats. \5\
---------------------------------------------------------------------------
\5\ See Attachment 2, 3.2 Access to Proxy.
The Council is in the process of submitting a comment letter to the
SEC on the Commission's outstanding proposal, Facilitating Shareholder
Director Nominations. \6\ While we have some suggested enhancements,
the Council by and large is very supportive of the proposal. We firmly
believe that a Federal approach is far superior to a State-by-State
system.
---------------------------------------------------------------------------
\6\ 74 Fed. Reg. 29,024 (proposed June 18, 2009), http://
www.sec.gov/rules/proposed/2009/33-9046.pdf.
---------------------------------------------------------------------------
The Council believes Congress should support the SEC's efforts by
affirming the Commission's authority to promulgate rules allowing
shareowners to place their nominees for director on management's card.
The Council believes the SEC has the authority to approve an access
standard. However others disagree, and the Commission is likely to face
unnecessary, costly and time-consuming litigation in response to a
Commission-approved access mechanism. To ensure that owners of U.S.
companies face no needless delays over the effective date of this
critical reform, the Council recommends Congressional affirmation of
the SEC's authority.
Of note, the Council believes access to the proxy complements
majority voting for directors. Majority voting is a tool for
shareowners to remove directors. Access is a tool for shareowners to
elect directors.
Executive Compensation Reforms
As long-term investors with a significant stake in the U.S. capital
markets, Council members have a vested interest in ensuring that U.S.
companies attract, retain, and motivate the highest performing
employees and executives. They are supportive of paying top executives
well for superior performance.
However, the financial crisis has offered yet more examples of how
investors are harmed when poorly structured executive pay packages
waste shareowners' money, excessively dilute their ownership in
portfolio companies, and create inappropriate incentives that reward
poor performance or even damage a company's long-term performance.
Inappropriate pay packages may also suggest a failure in the boardroom,
since it is the job of the board of directors and the compensation
committee to ensure that executive compensation programs are effective,
reasonable, and rational with respect to critical factors such as
company performance and industry considerations.
The Council believes executive compensation issues are best
addressed by requiring companies to provide full, plain English
disclosure of key quantitative and qualitative elements of executive
pay, by ensuring that corporate boards can be held accountable for
their executive pay decisions through majority voting and access
mechanisms, by giving shareowners meaningful oversight of executive pay
via nonbinding votes on compensation and by requiring disgorgement of
ill-gotten gains pocketed by executives.
Advisory Vote on Compensation: The Council believes an
annual, advisory shareowner vote on executive compensation
would efficiently and effectively provide boards with useful
information about whether investors view the company's
compensation practices to be in shareowners' best interests.
Nonbinding shareowner votes on pay would serve as a direct
referendum on the decisions of the compensation committee and
would offer a more targeted way to signal shareowner discontent
than withholding votes from committee members. They might also
induce compensation committees to be more careful about doling
out rich rewards, to avoid the embarrassment of shareowner
rejection at the ballot box. In addition, compensation
committees looking to actively rein in executive compensation
could use the results of advisory shareowner votes to stand up
to excessively demanding officers or compensation consultants.
Of note, to ensure meaningful voting results, Federal
legislation should mandate that annual advisory votes on
compensation are a ``nonroutine'' matter for purposes of New
York Stock Exchange Rule 452.
Independent Compensation Advisers: Compensation consultants
play a key role in the pay-setting process. The advice provided
by these consultants may be biased as a result of conflicts of
interest. Most firms that provide compensation consulting
services also provide other kinds of services, such as benefits
administration, human resources consulting, and actuarial
services. Conflicts of interest contribute to a ratcheting up
effect for executive pay and should thus be minimized and
disclosed.
Stronger Clawback Provisions: The Council believes a tough
clawback policy is an essential element of a meaningful ``pay
for performance'' philosophy. If executives are rewarded for
``hitting their numbers''--and it turns out that they failed to
do so--they should not profit. While Section 304 of the
Sarbanes-Oxley Act gave additional authority to the SEC to
recoup bonuses or other incentive-based compensation in certain
circumstances, some observers have suggested this language is
too narrow and perhaps unworkable. The Council does not
advocate a reopening of the Sarbanes-Oxley Act, but it does
recommend that Congress consider ways to cover cases where
performance-based compensation may be ``unearned'' in
retrospect but not meet the high standard of ``resulting from
misconduct'' required by Section 304.
Enhanced Disclosures: Of primary concern to the Council is
full and clear disclosure of executive pay. As U.S. Supreme
Court Justice Louis Brandeis noted, ``sunlight is the best
disinfectant.'' Transparency of executive pay enables
shareowners to evaluate the performance of the compensation
committee and board in setting executive pay, to assess pay-
for-performance links and to optimize their role of overseeing
executive compensation through such means as proxy voting. The
Council is very supportive of the SEC's continued efforts to
enhance the disclosure of executive compensation, including its
recent proposal to require disclosures about (1) how overall
pay policies create incentives that can affect the company's
risk and management of risk; (2) the grant date fair value of
equity-based awards; and (3) remuneration to executive/director
compensation consultants. We believe the disclosure regime in
the U.S. would be substantially improved if companies would
have to disclose the quantitative measures used to determine
incentive pay. Such disclosure--which could be provided at the
time the measures are established or at a future date, such as
when the performance related to the award is measured--would
eliminate a major impediment to the market's ability to analyze
and understand executive compensation programs and to
appropriately respond.
As indicated earlier in my testimony, the Council believes that a
federally imposed standard for majority voting for directors and a SEC-
approved access mechanism will be two of the most powerful tools for
addressing executive pay excesses and abuses. Their absence in the U.S.
corporate governance model effectively insulates directors from
meaningful shareowner oversight. We believe enhancing director
accountability via both mechanisms would help rein in excessive or
poorly structured executive pay packages.
Independent Board Chair
The issue of whether the chair and CEO roles should be separated
has long been debated in the U.S., where the roles are combined at most
publicly traded companies. Interest in the issue renewed in recent
years in the wake of Enron and other corporate scandals and, most
recently, in response to the financial crisis.
The U.S. approach to the issue differs from other countries,
particularly the U.K. and other European countries which have comply-
or-disclose requirements regarding the separation of the roles and/or
recommend it via nationally recognized best practices. According to the
Millstein Center for Corporate Governance and Performance at the Yale
School of Management:
Up until the early 2000s, the percentage of the S&P 500
companies with combined roles remained barely unchanged in the
previous 15 years, at 80 percent. Today, approximately 36
percent of S&P 500 companies have separate chairs and CEOs;
this is up from 22 percent in 2002. However, only 17 percent of
S&P 1500 firms have chairs that can be qualified as independent
and the incidence of independent chairs is concentrated on
small and midcap firms. This is in sharp contrast to the
landscape of other countries. \7\
---------------------------------------------------------------------------
\7\ ``Chairing the Board: The Case for Independent Leadership in
Corporate North America'' 17 (2009), http://millstein.som.yale.edu/
2009%2003%2030%20Chairing%20The%20Board.pdf [hereinafter ``Chairing''].
At the heart of the issue is whether the leadership of the board
should differ from the leadership of the company. Clearly the roles are
different, with management responsible for running the company and the
board charged with overseeing management. The chair of the board is
responsible for, among other things, presiding over and setting agendas
for board meetings. The most significant concern over combining the
roles is that strong CEOs could exert a dominant influence on the board
and the board's agenda and thus weaken the board's oversight of
management.
The Conference Board Commission on Public Trust and Private
Enterprise discussed the issue in its post-Enron corporate governance
report. \8\ The Commission suggested three approaches--including naming
an independent chair--for ensuring the appropriate balance of power
between board and CEO functions, and it recommended that ``each
corporation give careful consideration, based on its particular
circumstances, to separating the offices of the Chairman and Chief
Executive Officer.'' \9\
---------------------------------------------------------------------------
\8\ The Conference Board, Commission on Public Trust and Private
Enterprise 19 (Jan. 9, 2003),http://www.conference-board.org/pdf_free/
SR-03-04.pdf.
\9\ Id.
---------------------------------------------------------------------------
The Council believes separating the chair/CEO positions
appropriately reflects the differences in the roles, provides a better
balance of power between the CEO and the board--particularly when the
CEO dominates the board, and facilitates strong, independent board
leadership/functioning.
What information exists about the potential impact of various
approaches to improving corporate governance regulation?
Empirical evidence from companies in the U.S. and countries around
the globe support the reforms recommended by the Council.
Majority Voting for Directors
Majority voting for directors is not an alien concept. It is
standard practice in the United Kingdom, France, Germany, and other
European nations. And as discussed, it is also in place at some U.S.
companies. The experiences in these countries and in the U.S. indicate
that majority voting is not harmful to the markets and does not result
in dramatic and frequent changes to corporate boards.
Shareowner Access to the Proxy
Shareowner access to the proxy is a common right in countries
around the globe. According to Glass Lewis, the shareowners of
companies in the following countries are provided an access mechanism
(Country/Requirement):
Australia--Minimum of 5 percent
Canada--Minimum of 5 percent
China--Minimum of 1 percent
Finland--Minimum of 10 percent
Germany--Minimum of 5 percent of the issued share capital
or shares representing at least =500,000 of the company's share
capital
India--Deposit of INR 500, refundable if the nominee is
elected
Italy--Minimum of 2.5 percent of the company's share
capital
Russia--Minimum of 2 percent of the voting stock
South Africa--Minimum of 5 percent
United Kingdom--Minimum of 5 percent or at least 100
shareowners each with shares worth a minimum of 100
In addition, a handful of U.S. companies--including Apria
Healthcare and RiskMetrics--have voluntarily adopted access mechanisms.
And Delaware recently revised its corporation code to allow corporate
bylaws to require that a company's proxy include shareowner nominees
for director along with management candidates. The experiences in these
countries and in the U.S. indicate that proxy access is not harmful to
the markets. Indeed these mechanisms have rarely been used by owners in
these markets--powerful evidence that the existence of the mechanism
may enhance board performance and board-shareowner communications.
Advisory Vote on Compensation
According to the CFA Institute Centre for Financial Market
Integrity, the following countries have some form of shareowner vote on
executive compensation:
Australia
France
Germany (51 percent of companies researched provide such a
vote)
India
Italy
Poland
Switzerland
Taiwan
United Kingdom \10\
---------------------------------------------------------------------------
\10\ CFA Institute Centre for Financial Market Integrity,
Shareowner Rights Across the Markets: A Manual for Investors (2009),
http://www.cfapubs.org/doi/pdf/10.2469/ccb.v2009.n2.1.
Again, the experiences in these markets suggest that advisory votes
on compensation are not harmful to the markets. And the fact that few
compensation schemes are voted down suggests that shareowners are
careful stewards of their voting responsibilities and that advisory
votes do not require dramatic ``rearview mirror'' adjustments to pay.
Independent Board Chair
Nonexecutive chairs are common in many countries outside the United
States. Some 79 percent of companies in the United Kingdom's FTSE 350
index report that they have independent chairs. \11\ Splitting the role
of chair and CEO is the norm also in Australia, Belgium, Brazil,
Canada, Germany, the Netherlands, Singapore, and South Africa. \12\
Again, the experiences in these markets suggest that independent board
chairs are not harmful to the markets.
---------------------------------------------------------------------------
\11\ Chairing, supra note 7, at 17.
\12\ Id.
---------------------------------------------------------------------------
Conclusion
The Council is not the only group advocating corporate governance
reforms. The Investors' Working Group, an independent task force
cosponsored by the Council and the CFA Institute Centre for Financial
Market Integrity, issued July 15 a report recommending a set of reforms
to put the U.S. financial regulatory system on sounder footing and make
it more responsive to the needs of investors. \13\ Noting that
``investors need better tools to hold managers and directors
accountable,'' its recommendations include six corporate governance
reforms:
---------------------------------------------------------------------------
\13\ See Attachment 4.
In uncontested elections, directors should be elected by a
---------------------------------------------------------------------------
majority of votes cast.
Shareowners should have the right to place director
nominees on the company's proxy.
Boards of directors should be encouraged to separate the
role of chair and CEO or explain why they have adopted another
method to assure independent leadership of the board.
Securities exchanges should adopt listing standards that
require compensation advisers to corporate boards to be
independent of management.
Companies should give shareowners an annual, advisory vote
on executive compensation.
Federal clawback provisions on unearned executive pay
should be strengthened. \14\
---------------------------------------------------------------------------
\14\ Id. at 22-23.
The Administration, legislators, and regulators have also
recognized the need for corporate governance enhancements. The Council
commends the SEC for its bold efforts to date, and it applauds the
Obama administration and leaders on Capitol Hill for evaluating
corporate governance issues and, in some cases, proposing formal
reforms. Many of these proposals would address the key governance
shortfalls identified by the Council.
Thank you, Mr. Chairman for inviting me to participate at this
hearing. I look forward to the opportunity to respond to any questions.
Attachments
1. Council of Institutional Investors (Council) General Members
2. Council Corporate Governance Policies
3. Council Corporate Governance Reform Advocacy Letter (December 2008)
4. U.S. Financial Regulatory Reform: The Investors' Perspective, a
Report by the Investors' Working Group
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF JOHN J. CASTELLANI
President, Business Roundtable
July 29, 2009
Introduction
Business Roundtable (www.businessroundtable.org) is an association
of chief executive officers of leading U.S. companies with more than $5
trillion in annual revenues and nearly 10 million employees. Member
companies comprise nearly a third of the total value of the U.S. stock
markets and pay nearly half of all corporate income taxes paid to the
Federal Government. Annually, they return $133 billion in dividends to
shareholders and the economy. Business Roundtable companies give more
than $7 billion a year in combined charitable contributions,
representing nearly 60 percent of total corporate giving. They are
technology innovation leaders, with $70 billion in annual research and
development spending--more than a third of the total private R&D
spending in the United States.
We appreciate the opportunity to participate in this hearing on
``Protecting Shareholders and Restoring Public Confidence by Improving
Corporate Governance.'' Business Roundtable has long been at the
forefront of efforts to improve corporate governance. We have been
issuing ``best practices'' statements in this area for three decades,
including Principles of Corporate Governance (November 2005), The
Nominating Process and Corporate Governance Committees: Principles and
Commentary (April 2004), Guidelines for Shareholder-Director
Communications (May 2005), and Executive Compensation: Principles and
Commentary (January 2007) (attached as Exhibits I through IV). More
recently, Business Roundtable became a signatory to Long-Term Value
Creation: Guiding Principles for Corporations and Investors, also known
as The Aspen Principles, a set of principles drafted in response to
concerns about the corrosiveness that short-term pressures exert on
companies. The signatories to The Aspen Principles are a group of
business organizations, institutional investors and labor unions,
including the AFL-CIO, Council of Institutional Investors, and TIAA-
CREF, who are committed to encouraging and implementing best corporate
governance practices and long-term management and value-creation
strategies. In addition, Business Roundtable recently published its
Principles for Responding to the Financial Markets Crisis (2009)
(attached as Exhibit V), and many of our suggestions have been
reflected in the Administration's proposal to reform the financial
regulatory system.
At the outset, we must respectfully take issue with the premise
that corporate governance was a significant cause of the current
financial crisis. \1\ It likely stemmed from a variety of complex
financial factors, including major failures of a regulatory system,
over-leveraged financial markets and a real estate bubble. \2\ But even
experts disagree about the crisis's origins. \3\ Notably, with the
support of Business Roundtable, Congress recently established the
Financial Crisis Inquiry Commission to investigate the causes of the
crisis. \4\
---------------------------------------------------------------------------
\1\ See Lawrence Mitchell, ``Protect Industry From Predatory
Speculators'', Financial Times, July 8, 2009. Professor Mitchell, a
George Washington University law professor, argues that it is
``hyperbolic'' to suggest that inattentive boards had anything
significant to do with the current recession.
\2\ See Robert G. Wilmers, ``Where the Crisis Came From'', The
Washington Post, July 27, 2009.
\3\ Ben S. Bernanke, ``Four Questions About the Financial Crisis''
(Apr. 14, 2009), available at http://www.federalreserve.gov/newsevents/
speech/bernanke20090414a.htm.
\4\ Stephen Labton, ``A Panel Is Named To Examine Causes of the
Economic Crisis'', N.Y. Times, July 16, 2009, at B3.
---------------------------------------------------------------------------
Because the recently established Financial Crisis Inquiry
Commission is just starting its work, any attempt to make policy in
response to those purported causes would seem premature. In fact, a
legitimate concern is that many of the proposals currently being
suggested could even exacerbate factors that may have contributed to
the crisis. For example, commentators have asserted that the emphasis
of certain institutional investors on short-term gains at the expense
of long-term, sustainable growth played a role in the crisis. \5\ Some
of the current corporate governance proposals, including a universal
``say-on-pay'' right and the Securities and Exchange Commission's
recent proposal for a mandatory process access regime, may actually
exacerbate the emphasis on short-term gains. One large institutional
investor, the New Jersey State Investment Council, recently expressed
this concern, stating that, ``we do not want a regime where the primary
effect is to empower corporate raiders with a short-term focus.'' \6\
Thus, we must be cautious that in our zeal to address the financial
crisis, we do not jeopardize companies' ability to create the jobs,
products, services and benefits that improve the economic well-being of
all Americans.
---------------------------------------------------------------------------
\5\ See Lawrence Mitchell, ``Protect Industry From Predatory
Speculators'', Financial Times, July 8, 2009.
\6\ Letter from Orin S. Kramer, Chair, New Jersey State Investment
Council to Mary Schapiro, Chairman, Securities and Exchange Commission
re: comments on File S7-10-09 (July 9, 2009).
---------------------------------------------------------------------------
Moreover, the problems giving rise to the financial crisis occurred
at a specific group of companies in the financial services industry.
Having the Federal Government impose a universal one-size-fits-all
corporate governance regime on all public companies based on the
experience at a small subset of companies could undermine the stability
of boards of directors and place corporations under even greater
pressure for short-term performance.
We also cannot ignore the sweeping transformation in corporate
governance practices in the past 6 years, many of which have been
adopted voluntarily by corporations, sometimes in response to
shareholder requests. Similarly, State corporate law has been the
bedrock upon which the modern business corporation has been created and
it remains the appropriate and most effective source for law as it
applies to corporate governance. It has been responsive to developments
in corporate governance, most recently to majority voting for
directors, proxy access, and proxy contest reimbursement. Further, the
SEC plays an active role in seeing that shareholders receive the
information they need to make informed voting decisions, and, in this
regard, recently has issued a number of proposals designed to provide
shareholders with additional corporate governance information.
Recent Developments in Corporate Governance
The past few years have seen a sea change in corporate governance
through a combination of legislation, rule making by the SEC and the
securities markets and voluntary action by companies. As long-time
advocates for improved corporate governance, Business Roundtable has
supported and helped effect many of these changes while simultaneously
working to ensure that they provide necessary operational flexibility
and avoid unintended negative consequences.
Board Independence
In the past several years, public companies have taken a number of
steps to enhance board independence. First, there has been a
significant increase in the number of independent directors serving on
boards. A 2008 Business Roundtable Survey of member companies (attached
as Exhibit VI) indicated that at least 90 percent of our member
companies' boards are at least 80 percent independent. According to the
RiskMetrics Group 2009 Board Practices, average board independence at
S&P 1,500 companies increased from 69 percent in 2003 to 78 percent in
2008. According to the same study, in 2008, 85 percent of S&P 1,500
companies, and 91 percent of S&P 500 companies, had boards that were at
least two-thirds independent.
Second, directors increasingly meet in regular ``executive
sessions'' outside the presence of management and 75 percent of our
member companies hold executive sessions at every meeting, compared to
55 percent in 2003. Moreover, the NYSE listing standards require a
nonmanagement director to preside over these executive sessions and
require companies to disclose in their proxy materials how interested
parties may communicate directly with the presiding director or the
nonmanagement directors as a group.
Third, there has been a steady increase in the number of companies
that have appointed a separate chairman of the board. According to the
RiskMetrics Group 2009 Board Practices survey, from 2003 to 2008, the
number of S&P 1,500 companies with separate chairmen of the board
increased from 30 percent to 46 percent. Moreover, many companies
without an independent chair have appointed a lead or presiding
director in order to provide for independent board leadership. A 2007
Business Roundtable survey of member companies indicated that 91
percent of companies have an independent chairman or an independent
lead or presiding director, up from 55 percent in 2003. According to
the 2008 Spencer Stuart Board Index, by mid-2008, 95 percent of S&P 500
companies had a lead or presiding director, up from 36 percent in 2003.
Lead directors' duties are often similar to those of an independent
chairman and include: presiding at all meetings of the board at which
the chairman is not present, including executive sessions of the
independent directors; serving as liaison between the chairman and
independent directors; approving information sent to the board;
approving meeting agendas for the board; approving meeting schedules to
assure that there is sufficient time for discussion of all agenda
items; having authority to call meetings of the independent directors;
being available for consultation and direct communication with major
shareholders; and serving as interim leadership in the event of an
emergency succession situation. Many companies provide information
about their board leadership structures in their corporate governance
guidelines, their proxy statements or both, and the SEC recently has
proposed to require disclosure about a company's leadership structure
and why that structure is appropriate for the company.
Finally, various organizations are focusing on voluntary steps that
companies can take to enhance independent board leadership. In the
spring of 2009, the National Association of Corporate Directors, with
the support of Business Roundtable, issued a set of Key Agreed
Principles To Strengthen Corporate Governance for U.S. Publicly Traded
Companies. One ``key agreed principle'' states that boards should have
independent leadership, either through an independent chairman or a
lead/presiding director, as determined by the independent directors.
The principles further recommend that boards evaluate their independent
leadership annually. In March 2009, the Chairman's Forum, an
organization of nonexecutive chairmen of U.S. and Canadian public
companies, issued a policy briefing calling on companies to appoint an
independent chairman upon the succession of any combined chairman/CEO.
The policy briefing recognizes, however, that particular circumstances
may warrant a different leadership structure and recommends, in these
instances, that companies explain to shareholders why combining the
positions of chairman and CEO represents a superior approach.
Majority Voting and Annual Elections
Companies also have taken steps to enhance accountability through
the adoption of majority voting standards for the election of directors
and the establishment of annual elections for directors. Historically,
most U.S. public companies have used a plurality voting standard in
director elections. Under plurality voting, the director nominees for
available board seats who receive the highest number of ``For'' votes
are elected. In a typical annual election, the number of nominees
equals the number of available Board seats, so if at least one share is
voted ``For'' the election or reelection of a nominee, the nominee will
gain or retain a seat on the Board. Accordingly, director nominees in
uncontested elections are assured election. Under a majority voting
regime, a candidate must receive a majority of votes cast in order to
retain his or her board seat. Majority voting thus increases
shareholder influence and encourages greater board accountability.
In 2004, several labor unions and other shareholder groups began to
broadly advocate that companies adopt a majority vote standard in
uncontested director elections, in order to demonstrate directors'
accountability to shareholders. Companies and shareholders alike
recognized the merits of a majority voting standard and this corporate
governance enhancement was quickly adopted by many companies. According
to our 2008 Survey of Corporate Governance Trends, 75 percent of our
member companies have adopted some form of majority voting for
directors. According to the leading study on majority voting, as of
October 2008, more than 70 percent of S&P 500 companies had adopted
some form of majority voting, as compared with only 16 percent in 2006,
\7\ and mid- and small-cap companies increasingly are adopting majority
voting as well. \8\
---------------------------------------------------------------------------
\7\ Melissa Klein Aguilar, ``Shareholder Voice Getting Louder,
Stronger'', Compliance Week (Oct. 21, 2008) available at http://
www.complianceweek.com/article/5113/shareholder-voices-getting-louder-
stronger (quoting Claudia Allen, author of Study of Majority Voting in
Director Elections).
\8\ See Claudia H. Allen, Study of Majority Voting in Director
Elections (Feb. 5, 2007) available at http://www.ngelaw.com/files/
upload/majoritystudy111207.pdf.
---------------------------------------------------------------------------
A growing number of companies have moved to annual director
elections too. According to the RiskMetrics Group 2009 Board Practices
survey, 64 percent of S&P 500 companies held annual director elections
in 2008 as compared to only 44 percent in 2004. Likewise, 50 percent of
S&P 1,500 companies held annual director elections in 2008, and the
number of S&P 1,500 companies with classified boards had decreased to
50 percent in 2008 from 61 percent in 2004. The decrease in the
prevalence of classified boards is reflected across mid- and small-cap
companies as well. \9\ However, as discussed below, there are reasons
why some companies believe it is in the best interests of their
shareholders to retain their classified boards.
---------------------------------------------------------------------------
\9\ See RiskMetrics Group, Board Practices: The Structure of
Boards of Directors at S&P 1,500 Companies (2008).
---------------------------------------------------------------------------
One Size Does Not Fit All
While Business Roundtable consistently has worked toward enhancing
corporate governance practices, we strongly believe that with respect
to many of these practices a ``one-size-fits-all'' approach simply will
not work. Companies vary tremendously in their size, shareholder base,
centralization and other factors that can change over time. Attempting
to shoehorn all companies, whether it is a Fortune 50 company or a
small company with a single significant shareholder, into the same
corporate governance regime deprives companies and their shareholders
of choices about the practices that will enable them to operate their
businesses in a way that most effectively creates the jobs, products,
services, and benefits that improve the economic well-being of all
Americans. In this regard, corporate governance initiatives intended to
improve corporate functioning and protect shareholders can actually end
up harming companies and the interests of the shareholders they were
meant to protect. This realization has been echoed by others including
the New Jersey Investment Council, which oversees the New Jersey $63
billion public pension system. The Council recently stated in a letter
to SEC Chairman Mary Schapiro that it is ``troubled by the
proliferation of rigid prescriptive responses. which are costly, time-
consuming, unresponsive to the individual fact settings surrounding
specific companies and industries, and which may correlate only
randomly with the creation of shareholder value.'' \10\
---------------------------------------------------------------------------
\10\ Letter from Orin S. Kramer, Chair, New Jersey State
Investment Council to Mary Schapiro, Chairman, Securities and Exchange
Commission re: comments on File S7-10-09 (July 9, 2009).
---------------------------------------------------------------------------
For instance, despite the increasing trend of annual director
elections, some companies have concluded that it is in the best
interest of their shareholders to retain a classified board. In this
regard, some economic studies have found that a classified board can
enhance a board's ability to negotiate the best results for
shareholders in a potential takeover situation by giving the incumbent
directors additional opportunity to evaluate the adequacy and fairness
of any takeover proposal, negotiate on behalf of all shareholders and
weigh alternative methods of maximizing shareholder value. \11\ In
addition, classified boards can have other advantages, including
greater continuity, institutional memory and stability, thereby
permitting directors to take a longer-term view with respect to
corporate strategy and shareholder value. Some recent proposed
legislation, however, would deprive boards of directors and
shareholders of this choice. \12\
---------------------------------------------------------------------------
\11\ See,, e.g., M. Sinan Goktan, et al., ``Corporate Governance
and Takeover Gains'' (Working Paper 2008) available at http://
www.fma.org/Texas/Papers/corpgov_takeovergains_fma2008.pdf; Lucian A.
Bebchuk, et al., ``The Powerful Antitakeover Force of Staggered Boards:
Theory'', Evidence and Policy, 54 Stanford L. Rev. 887-951 (2002).
\12\ See Shareholder Bill of Rights Act of 2009 S. 1074, 111th
Cong. 3 (2009).
---------------------------------------------------------------------------
Likewise, Business Roundtable believes that it is critical for
boards of directors to have independent board leadership, but a single
method of providing that leadership is not appropriate for all
companies at all times. While some companies have separated the
position of chairman of the board and chief executive officer, others
have voluntarily established lead independent or presiding directors.
This illustrates the need for, and advantages of, an individualized
approach and demonstrates that a universally mandated approach is
neither necessary nor desirable. \13\ It would, in fact, deprive boards
of directors, and indeed shareholders, of the flexibility to establish
the leadership structure that they believe will best equip their
companies to govern themselves most effectively for long-term growth
and value creation.
---------------------------------------------------------------------------
\13\ See Shareholder Bill of Rights Act of 2009 S. 1074, 111th
Cong. 5 (2009) and Shareholder Empowerment Act of 2009 H.R. 2861,
111th Cong. 2 (2009).
---------------------------------------------------------------------------
State Law Is the Bedrock for Effective Corporate Governance
Historically, for more than 200 years, State corporations statutes
have been the primary source of corporate law and have enabled
thoughtful and effective corporate governance policies and practices to
be developed. In large part, this stems from the flexibility and
responsiveness of State corporate law in responding to evolving
circumstances. In this regard, State corporate law is described as
``enabling'' because it generally gives corporations flexibility to
structure their governance operations in a manner appropriate to the
conduct of their business. It also preserves a role for private
ordering and shareholder choice by permitting shareholder proposed
bylaws to address corporate governance issues.
Where a corporation and its shareholders determine that a
particular governance structure--such as a majority voting regime--is
appropriate, enabling statutes permit, but do not mandate, its
adoption. And when changes in State corporate law are determined to be
necessary, such as to facilitate changes to a majority voting standard,
States responded by amending their statutes. For example, Delaware
amended its corporate law to provide that, if shareholders approve a
bylaw amendment providing for a majority vote standard in the election
of directors, a company's board of directors may not amend or repeal
the shareholder-approved bylaw. \14\ Other States have also amended
their corporations statutes to address majority voting as well,
including California, Nevada, North Dakota, Ohio, Utah, and others.
\15\ In addition, the American Bar Association approved amendments to
the Model Business Corporation Act, which 30 States have adopted,
permitting a company's board or shareholders to adopt majority voting
in director elections through bylaw amendments rather than through a
more cumbersome process. \16\
---------------------------------------------------------------------------
\14\ Delaware General Corporations Law 216 (2009).
\15\ See California Corporations Code 708.5 (2009); Nevada
General Corporation Law 330 (2009); North Dakota Century Code 10-35-
09 (2009); Ohio General Corporation Law 1701.55 (2009); and Utah
Revised Business Corporation Act 728 (2009).
\16\ Model Business Corporation Act 10.22 (2006).
---------------------------------------------------------------------------
Most recently, in April of this year, Delaware amended its
corporate law to clarify the ability of companies and their
shareholders to adopt proxy access bylaws, as well as bylaws providing
for the reimbursement of expenses incurred by a shareholder in
connection with the solicitation of proxies for the election of
directors. \17\ New Section 112 of the Delaware General Corporation Law
permits a company to amend its bylaws to provide that shareholders may
include in the company's proxy materials shareholder nominees for
director positions. The bylaws may condition the obligation to include
shareholder nominees on the satisfaction of eligibility requirements
and/or compliance with procedures set forth in the bylaws. New Section
113 permits shareholders to adopt bylaws that require the company to
reimburse expenses incurred by a shareholder in connection with the
solicitation of proxies for the election of directors. The American Bar
Association is considering similar amendments to the Model Business
Corporation Act. \18\ Like the majority voting enabling legislation
described above, these reforms will allow companies and their
shareholders to determine whether the costs of proxy access and proxy
reimbursement outweigh the benefits for a particular company.
---------------------------------------------------------------------------
\17\ Delaware General Corporation Law 112 and 113.
\18\ See Press Release, American Bar Association Section of
Business Law, ``Corporate Laws Committee to Address Current Corporate
Governance Issues'' (Apr. 29, 2009).
---------------------------------------------------------------------------
In contrast to the enabling approach of State corporate law, some
recently proposed Federal legislation in response to the financial
crisis, the Shareholder Bill of Rights Act of 2009 \19\ and the
Shareholder Empowerment Act of 2009, \20\ would mandate specific board
structures. Such Federal Government intrusion into corporate governance
matters would be largely unprecedented as the Federal Government's role
in corporate governance traditionally has been limited. The Sarbanes-
Oxley Act of 2002 did not change the role of the States as the primary
source of corporate law; rather, it was a rare instance of Federal
action in the area of corporate governance.
---------------------------------------------------------------------------
\19\ See Shareholder Bill of Rights Act of 2009 S. 1074, 111th
Cong. 5 (2009).
\20\ See Shareholder Empowerment Act of 2009 H.R. 2861, 111th
Cong. 2 (2009).
---------------------------------------------------------------------------
Shareholders Have Effective Means of Influencing Corporate Governance
Under the existing corporate governance framework, shareholders
have the ability to make their views known to the companies in which
they invest through a variety of methods. First, many companies provide
means for shareholders to communicate with the board about various
matters, including recommendations for director candidates and the
director election process in general. In this regard, in 2003 the SEC
adopted rules requiring enhanced disclosure about companies' procedures
for shareholder communication with the board and for shareholders'
recommendations of director candidates. \21\ In addition, companies
listed on the New York Stock Exchange must have publicized mechanisms
for interested parties, including shareholders, to make their concerns
known to the company's nonmanagement directors. \22\ The SEC's 2008
rules regarding electronic shareholder forums also provided additional
mechanisms for communications between the board and shareholders. \23\
According to a 2008 survey, board members or members of management of
nearly 45 percent of surveyed S&P 500 companies reached out to
shareholders proactively. \24\
---------------------------------------------------------------------------
\21\ Disclosure Regarding Nominating Committee Functions and
Communications Between Security Holders and Boards of Directors,
Release No. 33-8340, 68 Fed. Reg. 69,204 (Dec. 11, 2003).
\22\ NYSE Listed Company Manual 303A.03.
\23\ Electronic Shareholder Forums, Release No. 34-57172, 73 Fed.
Reg. 4450 (Jan. 25, 2008). See also Jaclyn Jaeger, ``The Rise of Online
Shareholder Activism'', Compliance Week (Mar. 11, 2008), available at
http://www.complianceweek.com/article/4007/the-rise-of-online-
shareholder-activism (providing examples of successful online
shareholder activism).
\24\ Spencer Stuart Board Index at 28 (2008), available at http://
content.spencerstuart.com/sswebsite/pdf/lib/SSBI-2006.pdf.
---------------------------------------------------------------------------
Second, shareholders can submit proposals to be included in company
proxy materials. These proposals have been an avenue for shareholders
to express their views with respect to various corporate governance
matters. For example, the CEO of Bank of America stepped down as
chairman of the board this year after a majority of shareholders
approved a binding bylaw amendment requiring an independent chair for
the company's board. \25\ In addition, predatory shareholder proposals
can engender dialogue between companies and shareholder proponents
about corporate governance issues. \26\ In this regard, an advisory
vote on compensation has been implemented at several companies that
received shareholder proposals on this topic. \27\ Moreover, as
advocates of such votes have suggested that it is a way to enhance
communication between shareholders and their companies about executive
compensation, many companies have responded by employing other methods
to accomplish this goal. These include holding meetings with their
large shareholders to discuss governance issues, as well as using
surveys, blogs, webcasts and other forms of electronic communication
for the same purpose. \28\
---------------------------------------------------------------------------
\25\ Dan Fitzpatrick and Marshall Eckblad, ``Lewis Ousted as BofA
Chairman'', Wall St. J., Apr. 30, 2009, at A1.
\26\ Edward Iwata, ``Boardrooms Open Up to Investors' Input'', USA
Today, Sept. 7, 2009, available at http://www.usatoday.com/money/
companies/management/2007-09-06-shareholders-fight_N.htm.
\27\ Thus far, in 2009, shareholders have submitted shareholder
proposals to over 100 individual companies requesting an advisory vote
on executive compensation. In response to previous years' shareholder
proposals, many companies are providing shareholders with such a vote,
including Aflac Incorporated, H&R Block, Inc., Jackson Hewitt Tax
Service, Inc., Littlefield Corporation, RiskMetrics Group, Inc. and
Zale Corporation. At least 25 other companies including Intel
Corporation, Motorola, Inc. and Verizon Communications, Inc. have
agreed to hold an annual advisory vote voluntarily or in response to
their shareholders' concerns.
\28\ A 2007 Business Roundtable survey of member companies
indicated that in 2007, board members of 28 percent of companies met
with shareholders. Another survey indicates that in 2008, board members
or members of management of nearly 45 percent of S&P 500 companies
reached out to shareholders proactively. Other companies have
established e-mail links on their Web site for investors to provide
feedback to the compensation committee. And in April 2009, Schering-
Plough Corp. submitted a survey to its shareholders to obtain their
views on a variety of compensation issues.
---------------------------------------------------------------------------
Third, the proliferation of ``vote no'' campaigns in recent years
has provided shareholders with another method of making their views
known and effecting change in board composition. In these low-cost,
organized campaigns, shareholder activists encourage other shareholders
to withhold votes from or vote against certain directors. Although
``vote no'' campaigns do not have a legally binding effect where the
targeted company uses a plurality voting regime in an uncontested
election, evidence indicates that such campaigns are nonetheless
successful in producing corporate governance reform. \29\ For example,
following a 2008 ``vote no'' campaign at Washington Mutual in which
several shareholder groups called for shareholders to withhold votes
from certain directors, the finance committee chairman stepped down
upon receiving 49.9 percent withheld votes. \30\ In addition, a recent
study of ``vote no'' campaigns found that targeted companies
experienced improved post-campaign operating performance and increased
rates of forced CEO turnover, suggesting that ``vote no'' campaigns are
effective. \31\ At companies that have adopted majority voting in
director elections, ``vote no'' campaigns are likely to have an even
greater impact.
---------------------------------------------------------------------------
\29\ See Joseph A. Grundfest, `` `Just Vote No': A Minimalist
Strategy for Dealing With Barbarians Inside the Gates'', 45 Stan. L.
Rev. 857 (1993).
\30\ RiskMetrics Group 2008 Post-Season Report, at 10 (October
2008).
\31\ Diane Del Guercio, et al., ``Do Boards Pay Attention When
Institutional Investor Activists `Just Vote No' ?'', Journal of
Financial Economics, Oct. 2008.
---------------------------------------------------------------------------
Fourth, the existing framework allows shareholders to make their
views known through nominating their own director candidates and
engaging in election contests. In fact, they have done so recently at
companies including Yahoo! Inc. and Target Corporation. ``Short slate''
proxy contests in which dissidents seek board representation but not
full board control, have been very successful in recent years.
According to a recent study conducted by the Investor Responsibility
Research Center Institute, during a 4-year period, short slate proxy
contest dissidents were able to gain representation at approximately 75
percent of the companies they targeted. \32\ Significantly, in the
majority of these cases, dissidents found it unnecessary to pursue the
contest to a shareholder vote; instead, they gained board seats through
settlement agreements with the target companies. \33\ Clearly the
threat of proxy contests, to say nothing of the contests themselves, is
an effective mechanism for shareholder nomination of directors.
Moreover, the SEC adopted ``e-proxy'' rules in 2007 that permit
companies and others soliciting proxies from shareholders to deliver
proxy materials electronically, which has streamlined the proxy
solicitation process and greatly reduced the costs of printing and
mailing proxy materials. \34\ All of this has made it easier and less
costly for shareholders to nominate directors themselves.
---------------------------------------------------------------------------
\32\ Chris Cernich, et al., ``Investor Responsibility Research
Center Institute, Effectiveness of Hybrid Boards'', at 4 (May 2009),
available at http://www.irrcinstitute.org/pdf/
IRRC_05_09_EffectiveHybridBoards.pdf.
\33\ Id. at 4, 13 (noting that 76 percent of dissidents gaining
representation were able to do so through settlement).
\34\ Internet Availability of Proxy Materials, Exchange Act
Release No. 34-55146, 17 Fed. Reg. 240, 249 and 274 (March 30, 2007).
---------------------------------------------------------------------------
Finally, increasing numbers of companies have been amending their
governing documents to allow shareholders to call special meetings of
shareholders or, for companies that already allow shareholders to call
meetings, to lower the thresholds required to call those meetings.
Currently 45 percent of S&P 500 and 46 percent of S&P 1,500 companies
\35\ permit their shareholders to call special meetings, the majority
of which require either 25 percent or a majority of the outstanding
shares to call a special meeting. Beginning in 2007, shareholder
proponents began submitting a large number of shareholder proposals
requesting that 10 percent-20 percent of outstanding shares be able to
call special meetings. The number of such proposals has increased
dramatically since 2007 and these proposals have been receiving high
votes. \36\
---------------------------------------------------------------------------
\35\ Data provided by SharkRepellent.net (S&P 500) and RiskMetrics
Group, Inc. (S&P 1,500) as of June 2009.
\36\ Based on data from RiskMetrics Group, Inc. as of July, in
2009, shareholders have submitted special meeting shareholder proposals
to 74 individual companies. The average support for these votes has
been 52.3 percent, and 26 companies have received majority votes in
support of the proposal.
---------------------------------------------------------------------------
Clearly, there currently are numerous and potent methods that
shareholders can use to see that their voices are heard and their views
made known to the companies in which they invest. Accordingly,
proposals to increase shareholder rights must be considered in the
context of existing shareholder leverage and the manner in which
shareholders vote their shares. In this regard, the extensive reliance
of many institutional investors on the recommendations of the proxy
advisory services must be considered. Unfortunately, these services
often do not engage in company-by-company analysis when making their
recommendations, applying a one-size-fits-all approach to important
corporate governance decisions at individual companies.
The SEC Is Addressing Corporate Governance Matters
While, as noted above, State corporate law is central to corporate
governance, the SEC plays a role in assuring that shareholders receive
the information they need to make informed voting decisions, including
about corporate governance matters. In this regard, earlier this month,
the SEC proposed several rule changes intended to provide shareholders
with additional disclosure concerning individual director experience
and qualifications, board leadership structure and oversight of risk
management, compensation practices and potential conflicts of interest
with compensation consultants and compensation matters.
The proposed amendment relating to individual directors would
require companies to provide disclosure about (1) the experience,
qualifications, attributes and skills of directors and director
nominees that qualify them to serve as a director and as a member of
each committee on which they serve, (2) all public company
directorships held by directors and director nominees during the past 5
years, as opposed to just current directorships (as required under the
current rules), and (3) the involvement of directors, director nominees
and executive officers in legal proceedings during the prior 10 years.
With regard to board leadership, the proposal would require
disclosure about a company's board leadership structure and why the
structure is appropriate for the company. The proposed disclosure would
need to include a discussion of whether the company separates or
combines the roles of the chairman and chief executive officer, whether
the company has a lead independent director, and the board's role in
the company's risk-management process and the effects, if any, that
this role has on the company's board leadership structure.
Finally, the proposal relating to compensation consultant
disclosures would require enhanced disclosure of potential conflicts of
interest involving compensation consultants that provide advice to the
board or compensation committee regarding executive or director
compensation and also provide other services to the company.
Specifically, this disclosure would need to include a discussion of (1)
any other services that the compensation consultant or its affiliates
provide to the company and the fees paid for such services, (2) the
aggregate fees paid for advising on executive and director
compensation, (3) whether the consultant was engaged for these other
services by or on the recommendation of management, and (4) whether the
board or compensation committee approved these other services.
We believe that this disclosure approach to matters relating to
board leadership and risk oversight is far superior to the one-size-
fits-all approach in proposed legislation that would mandate the
separation of the chairman and CEO position and require all public
companies--no matter what size of industry--to establish a risk
committee of the board. \37\ Companies and their shareholders should
have the choice to determine the structures that will best enable them
to grow and prosper.
---------------------------------------------------------------------------
\37\ See Shareholder Bill of Rights Act of 2009 S. 1074, 111th
Cong. 5 (2009) and Shareholder Empowerment Act of 2009 H.R. 2861,
111th Cong. 2 (2009).
---------------------------------------------------------------------------
In addition to the corporate governance disclosure enhancements
described above, the SEC also approved an amendment to NYSE Rule 452,
which will prohibit brokers from voting uninstructed shares in director
elections. \38\ This rule amendment, which will be effective for annual
meetings after January 1, 2010, is likely to have a considerable impact
on the director election process, particularly for companies that have
adopted a majority voting standard.
---------------------------------------------------------------------------
\38\ Note that this amendment moots part of section 2 of the
Shareholder Empowerment Act of 2009. See Shareholder Empowerment Act of
2009 H.R. 2861, 111th Cong. 2 (2009) which would require that a broker
not be allowed to vote securities on an uncontested election to the
board of directors of an issuer to the extent that the beneficial owner
of those securities has not provided specific instructions to the
broker.
---------------------------------------------------------------------------
Another significant recent SEC action is the proposal to amend the
proxy rules to permit shareholders to nominate directors in a company's
proxy materials. If adopted, the proposed rules would establish a
Federal proxy access right and permit proxy access shareholder
proposals. The Federal process right would permit a shareholder or
group of shareholders to nominate one or more directors and have those
nominees included in a company's proxy materials contingent on the
shareholder or group beneficially owning a certain percentage of the
company's voting shares (which varies depending on a company's size)
for at least 1 year prior to submitting the nomination. Shareholders
meeting the proposal's requirements would be allowed to have their
proposed nominees (up to 25 percent of the board) included in the
company's proxy statement, on a first-come first-served basis.
In contrast to our support for the SEC's disclosure proposals, we
believe that the proposed Federal proxy access right could result in
serious, harmful consequences, as well as being beyond the SEC's
authority to adopt. First, widespread shareholder access to company
proxy materials will promote a short-term focus and encourage the
election of ``special interest'' directors who will disrupt boardroom
dynamics and jeopardize long-term shareholder value. Second, the
proposed rules will enhance the influence of proxy advisory firms and
institutional investors, which may use the rules as leverage for
advancing special interest causes and promoting policies to encourage
short-term gains in stock price. Third, the increased likelihood of
divisive and time-consuming annual election contests could deter
qualified directors from serving on corporate boards. Fourth,
shareholder-nominated directors could impede a company's ability to
satisfy board composition requirements. Finally, serious questions have
been raised about the ability of the current proxy voting system to
handle the increasing number of proxy contests that would result from
the implementation of the proxy access proposal. While the Commission's
proposing release touches upon some of these issues, it fails to
seriously address them. We currently are preparing a comment letter to
the SEC on these proposals which will expand upon our concerns.
Conclusion
Business Roundtable is committed to enhanced corporate governance
practices that enable U.S. companies to compete globally, create jobs
and generate long-term economic growth. We are concerned, however, that
in a rush to respond to the financial crisis, Congress, and the SEC,
are considering hastily prepared and universally applicable legislation
and regulation that will exacerbate some of the factors that led to the
crisis. In particular, an advisory vote on compensation and proxy
access could well increase the pressure on short-term performance to
the detriment of long-term value creation. The flexible approaches of
State corporate law, SEC disclosure and shareholder and company choice
that have produced the engine of economic growth that is the American
corporation should not be ignored.
Attachments
Exhibit I--Principles of Corporate Governance (November 2005)
Exhibit II--The Nominating Process and Corporate Governance Committees:
Principles and Commentary (April 2004)
Exhibit III--Guidelines for Shareholder-Director Communications (May
2005)
Exhibit IV--Executive Compensation: Principles and Commentary (January
2007)
Exhibit V--Principles for Responding to the Financial Markets Crisis
(2009)
Exhibit VI--2008 Business Roundtable Survey
EXHIBIT I
Principles of Corporate Governance (November 2005)
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
EXHIBIT II
The Nominating Process and Corporate Governance Committees: Principles
and Commentary (April 2004)
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
EXHIBIT III
Guidelines for Shareholder-Director Communications (May 2005)
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
EXHIBIT IV
Executive Compensation: Principles and Commentary (January 2007)
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
EXHIBIT V
Principles for Responding to the Financial Markets Crisis (2009)
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
EXHIBIT VI
2008 Business Roundtable Survey
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF J.W. VERRET
Assistant Professor of Law, George Mason University School of Law
July 29, 2009
The Misdirection of Current Corporate Governance Proposals
Chairman Reed, Ranking Member Bunning, and distinguished Members of
the Subcommittee, it is a privilege to testify in this forum today.
My name is J.W. Verret, and I am an Assistant Professor of Law at
George Mason Law School, a Senior Scholar at the Mercatus Center at
George Mason University and a member of the Mercatus Center Financial
Markets Working Group. I also direct the Corporate Federalism
Initiative, a network of scholars dedicated to studying the
intersection of State and Federal authority in corporate governance.
I will begin by addressing proxy access and executive compensation
rules under consideration and close with a list of contributing causes
for the present crisis.
I am concerned that some of the corporate governance proposals
recently advanced impede shareholder voice in corporate elections. This
is because they leave no room for investors to design corporate
governance structures appropriate for their particular circumstances.
Rather than expanding shareholder choice, these reforms actually
stand in the way of shareholder choice. Most importantly, they do not
permit a majority of shareholders to reject the Federal approach.
The Director of the United Brotherhood of Carpenters said it best,
``we think less is more, fewer votes and less often would allow us to
put more resources toward intelligent analysis.'' The Brotherhood of
Carpenters opposes the current proposal out of concern about compliance
costs. The proposals at issue today ignore their concerns, as well as
concerns of many other investors.
Consider why one might limit shareholders from choosing an
alternative means of shareholder access. It can only be because a
majority of the shareholders at many companies might reject the Federal
approach if given the opportunity.
Not all shareholders share similar goals. Public Pension Funds run
by State elected officials and Union Pension Funds are among the most
vocal proponents of shareholder power. Main street investors deserve
the right to determine whether they want the politics of Unions and
State Pension funds to take place in their 401(k)s.
The current proposals also envision more disclosure about
compensation consultants. Such a discussion would be incomplete without
mentioning conflicts faced by proxy advisory firms. Proxy advisory
firms advise institutional investors on how to vote. Current proposals
have failed to address this issue. The political clout enjoyed by these
firms is evidenced by the fact that the CAO of RiskMetrics, the
dominant firm in the industry, was recently hired as special advisor to
the SEC Chairman.
To close the executive compensation issue, I will note that if
executive compensation were to blame for the present crisis, we would
see significant difference between compensation policies at those
financial companies that recently returned their TARP money and those
needing additional capital. We do not.
Many of the current proposals also seek to undermine, and take
legislative credit for, efforts currently underway at the State level
and in negotiations between investors and boards. This is true for
proxy access, the subject of recent rule making at the State level, and
it is true for Federal proposals on staggered boards, majority voting,
and independent Chairmen.
The Sarbanes-Oxley Act passed in 2002 and was an unprecedented
shift in corporate governance designed to prevent poor management
practices. Between 2002 and 2008, the managerial decisions that led to
the current crisis were in full swing. I won't argue that Sarbanes-
Oxley caused the crisis, but this suggests that corporate governance
reform does a poor job of preventing crisis.
And yet, the financial crisis of 2008 must have a cause. I salute
this Committee's determination to uncover it, but challenge whether
corporate governance is the culprit. Let me suggest six alternative
contributing factors for this Committee to investigate:
i. The moral hazard problems created by the prospect of Government
bailout;
ii. The market distortions caused by subsidization of the housing
market through Fannie Mae, Freddie Mac, and Federal tax policy;
iii. Regulatory failure by the banking regulators and the SEC in
setting appropriate risk-based capital reserve requirements for
investment and commercial banks;
iv. Short-term thinking on Wall Street fed by institutional investor
fixation on firms making, and meeting, quarterly earnings
predictions;
v. A failure of credit-rating agencies to provide meaningful
analysis, caused by an oligopoly in that market supported by
regulation;
vi. Excessive write downs in asset values under mark-to-market
accounting, demanded by accounting firms who refused to sign
off on balance sheets out of concern about exposure to
excessive securities litigation risk.
Corporate governance is the foundation of American capital markets.
If this Committee tinkers with the American corporate governance system
merely for the appearance of change, it risks irreparable damage to
that foundation.
I thank you for the opportunity to testify, and I look forward to
answering your questions.
______
PREPARED STATEMENT OF RICHARD C. FERLAUTO
Director of Corporate Governance and Pension Investment,
American Federation of State, County, and Municipal Employees
July 29, 2009
Good Afternoon, Chairman Reed and Members of the Subcommittee. My
name is Richard Ferlauto, Director of Corporate Governance and
Investment Policy at the American Federation of State, County, and
Municipal Employees. AFSCME is the largest union in the AFL-CIO with
1.6 million members who work in the public service. Our members have
their retirement assets invested through public retirement systems with
more than one trillion dollars in assets. They depend on the earnings
of these systems to support their benefits in retirement. Large public
pension system investments in the public markets are diversified,
largely owning the market, and heavily indexed, which operate with time
horizons of 20 years or more to match the benefit obligations they have
to their plan participants. Indeed, public pension systems are the
foundation of patient capital investment in this economy, which seeks
long-term shareholder value creation.
AFSCME places strong emphasis on improving corporate governance
through direct company engagement, regulation, and legislation as a way
to achieve long-term shareholder value. As an active shareowner, we
have been a leading advocate for a shareholder advisory vote on CEO
compensation and shareholder proxy access to nominate directors on
company proxy materials.
I am also chairman of ShareOwners.org, a new nonprofit, nonpartisan
social network designed to give a voice to retailers or individuals who
rarely have opportunities to communicate with regulators, policy
makers, and the companies in which they are invested.
We urge the Committee to create better protections for the average
American investor in the financial marketplace. The severe losses
suffered by tens of millions of Americans in their portfolios, 401(k)s,
mutual funds, and traditional pension plans all point to the need for a
new emphasis on shareowner rights and meaningful regulation in order to
ensure the financial security of American families.
America has tried going down the road of financial deregulation and
reduced corporate accountability. That path has proven to be a dead end
that is now imperiling the financial well-being of millions of long-
term shareowners. Unfortunately, shareholders in America's
corporations--who actually should more correctly be thought of as
``shareowners''--have limited options today when it comes to protecting
themselves from weak and ineffectual boards dominated by management,
misinformation peddled as fact, accounting manipulation, and other
abuses.
Under the disastrous sway of deregulation and lack of
accountability, corporate boards and executives either caused or
allowed corporations to undertake unreasonable risks in the pursuit of
short-term financial goals that were devoid of real economic substance
or any long-term benefits. In most cases, it is long-term shareowners--
not the deregulators and the speculators--that are paying the price for
the breakdown in the system.
According to a recent scientific survey that the Opinion Research
Corporation conducted for ShareOwners.org of 1,256 U.S. investors,
``American investors clearly want to see tough action taken soon by
Congress to reform how our financial markets work and also to clean up
abuses on Wall Street. Support for such action is strong across all
groups by age, income, educational achievement and political
affiliation. It is particularly noteworthy that such a high percentage
of investors (34 percent) would use a term as strong as `angry' to
describe their views about the need for such action. And, even though
they are not angry, the additional nearly half of other investors (45
percent) who want to see strong clean-up action taken sends an
unmistakable message to policy makers. This is particularly true when
you look at that data alongside the finding that nearly 6 out of 10
investors (57 percent) said that strong Federal action would help to
restore their lost confidence in the fairness of the markets.'' The
full survey from ShareOwners.org is attached as an addendum to this
testimony [Ed. note: not included, please see http://
www.shareowners.org/profiles/blogs/read-all-about-it], but I would like
to point out the following findings:
More than four out of five American investors (83 percent)
agree that ``shareholders should be permitted to be actively
involved in CEO pay and other important issues that may bear on
the long-term value of a company to their retirement portfolio
or other fund.''
More than four out of five investors (82 percent) agree
that ``shareholders should have the ability to nominate and
elect directors of their own choosing to the boards of the
companies they own.'' Only 16 percent of Americans say that
``shareholders should NOT be able to propose directors to sit
on the boards of the companies they own.''
Nearly nine out of 10 investors (87 percent) say that
``investors who lose their retirement savings due to fraud and
abuse should have the right to go to court if necessary to
recover those funds.'' Only one in 10 American investors think
that ``investor lawsuits clog up the courts and make it more
expensive for companies to run their businesses.''
The number one reason for loss of investor confidence in
the markets: ``overpaid CEOs and/or unresponsive management and
boards'' at (81 percent).
It is time for America to get back on the road of prudent financial
regulatory oversight and increased corporate accountability. We urge
you to recognize the devastating impact that a lack of appropriate
regulation and accountability has had on our economy. In order to
restore the confidence of investors in our capital markets, it is now
necessary to take the following steps:
I. Strengthen the regulation of the markets. Key reforms needed to
protect the interests of shareowners include the following:
Beef up the Securities and Exchange Commission (SEC).
Congress should assess the funding needs of the SEC and take
steps to bring the agency as quickly as possible to the point
that it can fully carry out its mission of oversight of the
markets and financial professionals in order to protect and
advocate for investors. Among other priorities, the SEC should
impose requirements for the disclosure of long and short
positions, enhance disclosures for private equity firms bidding
for public companies, and require both the registration of
hedge fund advisors with the Commission as investment advisors
and additional disclosures of the underlying hedge fund.
Following the request of the Administration, the SEC should be
given additional authority to create a full-fledged fiduciary
standard for broker dealers, so that the interests of clients
who purchase investment products comes before the self interest
of the broker. The SEC Division of Enforcement should be
unshackled to prosecute criminal violations of the Federal
securities laws where the Department of Justice declines to
bring an action.
Clear the way for forfeiture of compensation and bonuses
earned by management in a deceptive fashion. Legislation should
be adopted to allow for the ``clawing back'' of incentive
compensation and bonuses paid to corporate executives based on
fraudulent corporate results, and should provide for
enforcement through a private right of action. There is no
reason why directors and executives should not give back ill-
gotten gains when innocent shareowners are victimized by
crippling losses. The outrageous bonuses at AIG, Morgan
Stanley, and other banks responsible for our financial meltdown
were not deserved and should not be allowed to stand. If they
know their compensation is on the line, corporate managers and
directors will be less likely to engage in or turn a blind eye
toward fraud and other wrongdoing.
Strengthen State-level shareowner rights. Corporation
structures and charters are regulated under State law. The
corporate law in most States has not clarified the rights,
responsibilities and powers of shareholders and directors or
ways that they should communicate outside of annual general
meetings. If regulation to strengthen shareholder rights does
not occur at the Federal level, it will be up to the States to
move forward. State corporate law should require proxy access,
majority voting and the reimbursement of solicitation expenses
in a board challenge. We would encourage robust competition
among States for corporate charters based on a race to the top
for improved shareowner rights. If necessary, Federal law
should be changed to allow for shareholders to call a special
meeting to reincorporate in another State by majority vote, in
order to avoid being shackled by the corporate State laws that
put the interests of management ahead of shareowners.
Protect whistleblowers and confidential sources who expose
financial fraud and other corporate misconduct. Confidential
informants--sometimes called ``whistleblowers''--are of
immeasurable value in discovering and redressing corporate
wrongdoing. The information provided by these individuals may
be crucial to victims' ability to prove their claims. Often,
these individuals only come forward because they believe their
anonymity will be preserved. If their identities were known,
they would be open to retaliation from their employers and/or
others with an interest in covering up the wrongdoing.
Whistleblowers might lose their job or suffer other harm.
Legislation is needed to clearly state that the corporate
whistleblowers and other confidential informants will be
protected when they step forward.
II. Increase the accountability of boards and corporate executives. Key
reforms needed to protect the interests of shareowners include
the following:
Allow shareowners to vote on the pay of CEOs and other top
executives. Corporate compensation policies that encourage
short-term risk-taking at the expense of long-term corporate
health and reward executives regardless of corporate
performance have contributed to our current economic crisis.
Shareowners should have the opportunity to vote for or against
senior executive compensation packages in order to ensure
managers have an interest in long-term growth and in helping
build real economic prosperity. The recently enacted stimulus
bill requires all companies receiving TARP bail-out funds,
nearly 400 companies, to include a ``say-on-pay'' vote at their
2009 annual meetings and at future annual meetings as long as
they hold TARP funds. It is now time for Congress to implement
Treasury Secretary Geithner's plan for compensation reform by
passing ``say-on-pay'' legislation for all companies and to
make it permanent as the center piece of needed reforms to
encourage executive accountability.
A key item to making the advisory vote meaningful will be not to
permit brokers to cast votes on management sponsored executive
compensation proposals as was recently done by the SEC in
support of changes to NYSE Rule 452 in board elections.
Stockbrokers who hold shares in their own name for their client
investors have no real economic interest in the underlying
corporation but can cast votes on routine items on the proxy.
These pay votes are not routine items and should not be treated
as such by investors, issuers or the regulators and we do not
believe would be the intent of Congress if they give
authorization to the SEC to require advisory votes on pay.
Brokers almost universally vote for management's nominees and
proposals and, in effect, interfere with shareowner supervision
of the corporations they own.
Empower shareowners to more easily nominate directors for
election on corporate boards through proxy access. The process
for nominating directors at American corporations is dominated
today by incumbent boards and corporate management. This is
because corporate boards control the content of the materials
that companies send to shareholders to solicit votes (or
``proxies'') for director elections, including the
identification of the candidates who are to be considered for
election. The result is that corporate directors often are
selected based on their allegiance to the policies of the
incumbent board, instead of their responsiveness to shareowner
concerns. Unless they can afford to launch an expensive
independent proxy solicitation, shareowners have little or no
say in selecting the directors who are supposed to represent
their interests. The solution is to enable shareowners, under
certain circumstances, to require corporate boards to include
information about candidates nominated by shareowners in the
company's proxy materials.
We are very encouraged that the SEC is in the process of rule
making on the issue but this is such an important right that we
believe that it should not become a political football for
future commissions. There needs to be long-term consistency in
securities law and the Exchange Act is the appropriate place to
clearly codify the authority that the Commission has to require
the disclosure of nominees running for board seats. And to
further enunciate that access to the proxy is fundamental to
free and fair elections for directors.
Require majority election of all members of corporate
boards at American companies. Corporate directors are the
elected representatives of shareowners who are responsible for
overseeing management. Under the default rule applicable to
virtually every corporation in the United States, however,
corporate directors can be elected with just a single
affirmative vote, even if that director's candidacy is opposed
by the overwhelming majority of shareowners. While a few
corporations have adopted policies that would require a
director to receive support of the majority of shareowners in
order to be elected, most corporations--particularly those not
in the S&P 500--have not. True majority voting should be
mandatory in every uncontested director election at all
publicly traded corporations.
Split the roles of chairman of the board and CEO in any
company. (1) receiving Federal taxpayer funds, or (2) operating
under Federal financial regulations. It already is the practice
in most of the world to divide these two key positions so that
an independent chairman can serve as a check on potential CEO
abuses. Separation of the CEO and board chair roles helps to
ensure good board governance and fosters independent oversight
to protect the long-term interests of private shareowners,
pension funds and institutional investors. A strong independent
chair can help to address legitimate concerns raised by
shareowners in a company. Splitting these roles and then
requiring a prior shareowner vote to reintegrate them would be
in the best interests of investors.
Allow shareowners to call special meetings. Shareowners
should be allowed to call a special meeting. Shareowners who
own 5 percent or more of the stock of a company should be
permitted, as they are in other countries, to call for a
special meeting of all shareowners. They also should be given
the right to call for a vote on reincorporation when management
and corporate boards unduly use State laws detrimental to
shareowner interests to entrench themselves further.
III. Improve financial transparency. Key reforms needed to protect the
interests of shareowners include the following:
Crackdown on corporate disclosure abuses that are used to
manipulate stock prices. Shareowners in securities fraud cases
have always had the burden of proving that defendants' fraud
caused the shareowners' losses. When corporate wrongdoers lie
to shareowners and inflate the value of publicly traded stock
through fraudulent and misleading accounting statements and
other chicanery, those culpable parties should be held
responsible for the damage wrought on the investing public that
is caused by their fraud. Defendants should not be allowed to
escape accountability to their shareowners for fraudulent
conduct simply by cleverly timing the release of information
affecting a company's stock price.
Improve corporate disclosures so that shareowners can
better understand long-term risks. To rebuild shareowner
confidence regulators should emphasize transparency by creating
more mechanisms for comprehensive corporate disclosure. The SEC
should devote particular attention to the adequacy of
disclosures concerning such key factors as credit risk,
financial opacity, energy and climate risk and those reflecting
the financial challenges to the economy as identified by the
transition team and the new Administration. The SEC should
develop internal expertise on issues such as environmental,
social, and governance factors that pose material financial
risks to corporations and shareowners, and also to require
disclosure of these types of risks.
Protect U.S. shareowners by promoting new international
accounting standards. Our current financial crisis extends far
beyond the borders of the U.S. and has affected financial
markets and investors across the globe. Part of the problem has
been a race to the bottom in favor of a more flexible
international accounting standard that would decrease
disclosure protection for the average investor. The current
crisis makes a compelling case for why we need to slow down the
movement toward the use of international accounting standards
that could provide another back door route to financial
deregulation and further erode confidence in corporate book
keeping. A slower time frame is necessary to protect
shareowners and allow the Administration to reach out to other
governments that share a commitment to high accounting and
transparency standards.
IV. Protect the legal rights of defrauded shareowners. Key reforms
needed to protect the rights of shareowners include the
following:
Preserve the right of investors to go to court to seek
justice. Corporate and financial wrongdoers in recent years
have effectively denied compensation to victims of fraud by
requiring customers to sign away their rights to access Federal
courts as individuals and participate with other victims in
class actions when their individual claims are small. Absent
the ability to proceed collectively, individuals have no means
of redress because--as the wrongdoers know--it is frequently
economically impossible for victims to pursue claims on an
individual basis. The ability of shareowners to take civil
actions against market wrongdoers provides an effective adjunct
to securities law enforcement and serves as a strong deterrent
to fraud and abuse. Shareowners should have the right to access
Federal courts individually or as a member of a class action.
Ensure that those who play a role in committing frauds bear
their share of the cost for cleaning up the mess. What is known
as private ``aiding and abetting'' liability is well
established in criminal law, and private liability for engaging
in an unlawful and fraudulent scheme is widely recognized in
civil law. In cases of civil securities fraud, however,
judicial decisions effectively have eliminated private
liability of so-called ``secondary actors''--even when they
knowingly participated in fraud schemes. Eliminating the
private liability of such ``secondary actors'' as corporate
accountants, lawyers and financial advisors has proven
disastrous for shareowners and the economy. Most recently, in
the subprime mortgage-backed securities debacle, bond rating
agencies--who were paid by the very investment bankers who
created the securities they were asked to rate--knowingly gave
triple-A ratings to junk subprime debt instruments in order to
generate more business from the junk marketers. The immunity
from private liability that these culpable third parties
currently enjoy should be eliminated.
Allow State courts to help protect investor rights. The
previous decade saw the greatest shift in governmental
authority away from the States and to the Federal Government in
our history. The effect of this shift was to deny individuals
their legal rights under State laws and to protect corporate
defendants. Corporate interests and an Administration devoted
to the ideology of deregulation used the ``doctrine of
preemption'' (that Federal law supersedes State law) to bar
action at the State level that could have stopped many of the
abuses in subprime mortgage lending that are now at the heart
of our economic crisis. Indeed, State attorneys general were
blocked from prosecuting subprime lenders who violated State
laws. The integrity of State law should be restored and both
State officials and shareowners should be allowed to pursue
remedies available under State law. Federal policy should make
clear that State law exists coextensively with Federal
regulations, except where State law directly contradicts
Federal law.
In conclusion, I would like to thank the Chairman for the
opportunity to testify today. Rebuilding investor confidence in the
market depends upon thoughtful policy making that expands investor
rights and authorizes the SEC to strengthen its advocacy role on behalf
of all Americans' financial security. I would be pleased to answer any
questions.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM MEREDITH B. CROSS
Q.1. There has been a lot of talk about giving shareholders a
vote on pay packages, but little discussion of the details. If
we were to require such a vote, what specifically should be
voted on, and how often?
A.1. As you noted, this topic has been widely discussed, and a
number of issues have been raised. One issue relates to what
precisely the shareholders would vote on if given a vote.
Shareholders could cast a nonbinding vote on the compensation
of executives, as disclosed pursuant to the Commission's
compensation disclosure rules. This is what Section 111(e) of
the Emergency Economic Stabilization Act of 2008 requires for
TARP recipients. Alternatively, shareholders could be asked to
cast a nonbinding vote on the company's compensation
philosophy, policies and procedures, as described in the
Compensation Discussion and Analysis. As you note, another
issue to consider would be the frequency of any such vote,
which some have suggested either be annually or once every 2-3
years. While these are just a few of the many issues that would
need to be considered with regard to shareholder advisory votes
on pay, the Commission has not expressed a view about this
topic.
As you may know, the Commission recently proposed rules to
implement the ``say-on-pay'' requirement in Section 111(e) of
the Emergency Economic Stabilization Act of 2008. The proposed
rule would require TARP recipients to provide a separate
shareholder vote to approve the compensation of the company's
executives in proxies solicited during the period in which any
obligation arising from Federal assistance provided under the
TARP remains outstanding. In the proposing release, the
Commission requested comment about whether the proposed rule
should include more specific requirements regarding the manner
in which TARP recipients should present the shareholder vote on
executive compensation. Any information received in response to
that request for comment will be instructive for the proposed
rule for TARP companies.
Q.2. How do we make sure boards can be an effective check on
management?
A.2. The recent market crisis has led many to raise serious
questions and concerns about the accountability and
responsiveness of companies and boards of directors, including
questions about whether boards are exercising appropriate
oversight of management. State corporate law and stock exchange
listing standards play an important role in addressing this
question. As for the Commission, in recent months, it has
worked diligently to address those questions and concerns. As
Chairman Schapiro has said, one of the most effective means of
providing accountability is to give shareholders a meaningful
opportunity to exercise the rights they have under State law to
nominate directors. The Commission's proposed rules to
facilitate the ability of shareholders to exercise their rights
to nominate directors would provide shareholders a greater
opportunity to hold directors accountable. The possibility that
shareholders may take advantage of the rules, if adopted, may
encourage directors to take a more active role in the oversight
of management.
The Chairman also has stated that shareholders should also
be informed about how compensation structures and practices
drive an executive's risk-taking. In an effort to improve the
information provided to shareholders on this topic, the
Commission recently proposed rules to require greater
disclosure about how a company and its board manage risks,
particularly in the context of setting and overseeing
compensation. Requiring companies to provide enhanced
disclosure in proxy statements about the relationship of a
company's overall compensation policies to risk would enable
shareholders to make more informed investment and voting
decisions.
Q.3. How do we make sure boards and management know what is
going on inside the large firms they are supposedly running?
A.3. The Chairman believes that directors must be sufficiently
independent of management so that they will ask the difficult
questions; directors also must be skilled enough to know what
questions need to be asked. A qualified and independent board
is the best means of ensuring that management is fully engaged.
While the Commission generally does not prescribe these
governance rules, the Commission's disclosure rules are
designed to provide investors--who elect directors--with
information about director independence and qualifications.
Q.4. Is a better approach to making sure boards and management
understand what is going on inside their companies to shrink
the size and scope of the companies?
A.4. I can assure you that the Commission understands the
concerns raised, in light of the recent turmoil in our markets,
about board and management oversight of companies; however,
determinations regarding the appropriate size and scope of
companies is probably best left to markets and shareholders.
While we will continue to consider ways that we can enhance our
disclosure rules to provide meaningful additional information
to investors, we know that Congress is also taking steps to
address corporate governance reforms. We look forward to
working with you as you move forward, and lending our expertise
where appropriate.
Q.5. For proxy access, how large of a block of shareholders
should have to request that the item be included?
A.5. The Commission recently proposed changes to the proxy
rules to facilitate shareholder director nominations, which is
often referred to as ``proxy access.'' Proposed Rule 14a-11
under the Exchange Act would require, under certain
circumstances, a company to include shareholder nominees for
director in the company's proxy materials. Under the proposed
rule, a nominating shareholder or group would be eligible to
have a nominee included in a company's proxy materials if the
nominating shareholder or group beneficially owns, as of the
date of the shareholder notice regarding the nomination, a
certain percentage of the company's securities entitled to be
voted on the election of directors, which range from 1 percent
to 5 percent depending on the size of the company. The proposal
would require a nominating shareholder to have held the
securities for at least 1 year. The staff will consider
carefully the comments submitted regarding ownership thresholds
and other requirements when making a recommendation to the
Commission as to the appropriate threshold for any final rule
adopted.
Q.6. What are issues that shareholders should have an opt out
or opt in vote on?
A.6. The idea of an opt in or opt out vote has been discussed
regarding a number of governance proposals. With respect to our
pending proposal to facilitate shareholder director
nominations, the Commission requested comment about whether or
not shareholders should be able to vote to opt out of the
proposed mechanism for shareholder director nominations, or
vote to choose a different mechanism to nominate directors. We
are currently considering the responses to our request for
comment on this issue, which reflect a wide range of views.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM JOHN C. COATES IV
Q.1. There has been a lot of talk about giving shareholders a
vote on pay packages, but little discussion of the details. If
we were to require such a vote, what specifically should be
voted on, and how often?
A.1. I would suggest following the U.K. model, as in S. 1074:
The shareholder advisory vote would be on the disclosure of
compensation to top executives as disclosed in the annual proxy
statement, as required by current SEC rules on compensation
disclosure and analysis, which calls for a specific report on
executive compensation.
Q.2. How do we make sure boards can be an effective check on
management?
A.2. Making boards effective checks on management is one of the
central goals of corporate governance--and as I emphasized in
my testimony, much uncertainty persists about how to best
achieve that goal, even among academic specialists who
generally agree on both that goal and how to study progress
toward that goal. In general, making sure that shareholders
have sufficient information and tools to nominate and elect
effective board members is a key first step. A second is to
make sure that boards themselves have effective access to
information (see answer to Question 3 below). A third is to
make sure that boards themselves have the incentives and
resources to take action when needed. Each of the steps I
favor--``say-on-pay''; making a split chairman/CEO split a
default rule for large operating companies, subject to opt out
by shareholders; and shareholder access of the kind proposed by
the SEC (subject to modifications that were suggested by a
number of professors at the Harvard Law and Business Schools,
including myself, available here: http://blogs.law.harvard.edu/
corpgov/files/2009/08/hbs_hls-letter-to-sec_0946.pdf--would be
helpful steps, as they would represent what are likely to be
modest improvements that do not impose irrevocable mandatory
rules or high costs on most companies. Still, it should be
recognized that ideal corporate governance is not likely to
ever be fully achieved, but is something that must be
continually pursued.
Q.3. How do we make sure boards and management know what is
going on inside the large firms they are supposedly running?
A.3. As firms grow in size in complexity, it may not be a
practical goal to expect boards or even top management to
always know everything is going on inside the firms they run,
any more than it is practical for officials in the U.S.
Government to know everything that is going on inside the
organization they oversee. What is important is enable
shareholders most effectively to choose and over time modify a
system of governance that provides both them and boards with
ready access to information about their companies, and with the
right incentives and tools to focus on the most important
activities their companies undertake, and the most important
risks their companies face. What has been disheartening about
the recent crisis is that well-regarded boards at prominent
financial companies did not seem to be aware of some of the
largest risks that their companies faced. This may suggest that
there may be natural limits to the size and complexity of an
organization that can be safely managed by fallible humans. But
if that is true, it would be better, in my view, to let
investors provide the feedback to boards about that fact, as
they raise the cost of capital for increased growth, or use
their rights as investors to control their companies, than for
such limits to be pursued directly as a matter of public
policy, as some have suggested (other than pursuant to existing
antitrust policy, which limits the concentration of any given
industry, and thus the size of firms operating in those
industries).
Q.4. Is a better approach to making sure boards and management
understand what is going on inside their companies to shrink
the size and scope of the companies?
A.4. See answer to Question 3.
Q.5. For proxy access, how large of a block of shareholders
should have to request that the item be included?
A.5. See http://blogs.law.harvard.edu/corpgov/files/2009/08/
hbs_hls-letter-to-sec_0946.pdf, where others and I suggest a
limit of 5-10 percent. However, as noted in my testimony, I do
not believe that this kind of detail in implementing proxy
access is something that should be done in legislation--but
rather, through SEC rule-making. The most important thing the
Congress can and should do on proxy access is to affirm in
clear terms that the SEC has the authority to adopt rules in
this area, and perhaps to mandate that the SEC revisit its
rules after some period of time, and/or report on the effects
of proxy access, perhaps with a statutory opt out right for
shareholders that do not want their companies to be subject to
such rules.
Q.6. What are issues that shareholders should have an opt out
or opt in vote on?
A.6. Nearly all rules of internal governance at public
companies should be subject to an opt out or an opt in by
shareholders. The only exceptions would be (a) where there is
some nonshareholder constituency that might be directly
affected by the decision to opt out, (b) where the rules
concern disclosure--which is the predicate for investors to
exercise their powers (including the power to opt out of
default governance provisions), or (c) where the rule is
designed to protect minority shareholders from majority or
control shareholders, as opposed to insure that managers serve
the interests of all shareholders. In general, I favor opt outs
where the evidence suggests that the rule in question is
beneficial for most companies, as with ``say-on-pay'' advisory
shareholder votes, or where the difficulty (legal and/or
financial) of opt ins is sufficiently high that shareholders
have a difficult time acting collectively to change the
governance rules at their companies, as with proxy access
(where a combination of costs and legal obstacles--such as past
decisions of the SEC itself--have long stymied efforts by
shareholders to implement their own rules requiring proxy
access). I favor opt ins where the rule is either best for a
minority of companies, or where evidence does not support any
particular rule as the best for most companies, as long as the
ability of shareholders to pursue their own governance systems
have not been effectively blocked by costs or legal
impediments.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM JOHN C. COATES IV
Q.1. Professor, in your testimony you support the idea of a
Government-mandated shareholder vote on compensation or a
``say-on-pay.'' You sight the ``improved link between executive
pay and corporate performance in the U.K.'' after its adoption
there even though only five companies in England have lost
shareholder votes on executive pay this year. Does it occur to
you that this ``say-on-pay'' model no longer works? The vast
majority of shares in the U.S. aren't held by an average
investor sitting at home. If it is true that shares are
primarily held by mutual funds and the ownership of the stock
is a derivative instrument. How does a Government-mandated
``say-on-pay'' vote get the participation that the 23 companies
in the U.S., who have already offered ``say-on-pay'' votes on
their own, not get?
A.1. The fact that few U.K. firms have lost ``say-on-pay''
votes is not a sign of ``say-on-pay's'' ineffectiveness. It
only takes a few high-profile losses for incumbent managers to
get the message. That is what the evidence suggests has
happened in the U.K. As I noted in my testimony, the best
evidence suggests that ``say-on-pay'' tightened the link
between pay design and performance, and that many firms
improved their pay practices both before and after ``say-on-
pay'' votes, including votes that were technically ``won''
because they received bare majorities in favor.
You are right that most stock is now held by institutions,
and only indirectly by individuals. Institutions such as mutual
funds, however, owe a responsibility to their investors to use
their voting power responsibly, and generally do so, in my
view. In effect, institutional investors are representative
bodies, as is the Senate. If institutional investors use their
``say-on-pay'' vote powers irresponsibly, they will be
disciplined by market forces in many instances, and where
markets do not effectively control institutional investors,
there may need to be regulation or reform of those institutions
through the political process--as may be the case, for example,
with public pension funds. But potential problems with
institutional shareholders have nothing to do with ``say-on-
pay''--if there are problems with institutions, they also
extend to ordinary voting rights that they already possess, to
vote for and against mergers, for example.
Finally, you ask why not continue to shareholders of
companies effectively opt in to ``say-on-pay,'' as a small
number of companies have done, rather than mandate ``say-on-
pay'' for all companies? To be clear, I believe that any ``say-
on-pay'' rule should permit shareholders to opt out of the
rule, and I would expect shareholders at some companies to do
so. The rule is thus not a ``mandate'' in the sense of
uniformly mandatory. Thus, the difference between the status
quo and the rule I would support boils down to whether one
thinks that most (not all) companies would be better off with
``say-on-pay.'' As my testimony suggests, the best evidence is
that ``say-on-pay'' advisory votes--which, after all, are only
advisory, and have no binding effect on companies--improve pay
practices generally, and thus would be good for most public
companies. What the adoption of ``say-on-pay'' would achieve is
to speed up the process of reform, and to eliminate the costs
associated with shareholder efforts to adopt the rules that a
small but growing number of companies have already adopted.
Those costs are substantial--to wage a proxy contest to
pressure managers to adopt ``say-on-pay'' rules requires
expensive lawyers and regulatory filings, all paid for by
shareholders, while incumbent managers use company (i.e.,
shareholder) funds to oppose those efforts, even (at times)
when managers know or expect most shareholders support the
rules.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM ANN YERGER
Q.1. There has been a lot of talk about giving shareholders a
vote on pay packages, but little discussion of the details. If
we were to require such a vote, what specifically should be
voted on, and how often?
A.1. There is broad agreement among Council members on the
inherent value of an advisory shareowner vote on executive
compensation as a feedback mechanism and dialogue tool, but
opinions differ on the frequency and type of votes. Many
investors, such as the AFSCME Employees Pension Plan, favor one
vote every year on the pay of the ``named executive officers
(NEOs) set forth in the proxy statement's Summary Compensation
Table (the ``SCT'') and the accompanying narrative disclosure
of material factors provided to understand the SCT (but not the
Compensation Discussion and Analysis).''
Annual, advisory shareowner votes on executive compensation
are required in Australia, Sweden, and the United Kingdom. In
fact, U.K. regulations requiring such votes went into effect in
2002, and are held on ``remuneration reports'' covering both
the quantitative and qualitative aspects of executive
compensation, including the nature of and rationale for
performance conditions tied to incentive payouts. ``Say-on-
pay'' votes in the U.K. have resulted in ``better disclosure,
better and more dialogue between shareholders and companies,
and more thought put into remuneration policy by directors,''
according to David Paterson, research director of U.K.-based
Research, Recommendations and Electronic Voting, a proxy
advisory service. British drugmaker GlaxoSmithKline (GSK) is a
case in point. In 2003, 51 percent of GSK shareowners protested
the CEO's golden parachute package by either voting against or
abstaining from voting on the company's remuneration report.
Stunned, the GSK board held talks with shareowners and the next
year reduced the length of executive contracts and set new
performance targets, muting investor criticism. Other U.K.
companies got the message and now routinely seek investor input
on compensation policies.
The annual-vote aspect of the AFSCME resolution and the
U.K. vote aligns with the Council's own policy on the subject,
which reads, ``All companies should provide annually for
advisory shareowner votes on the compensation of senior
executives.'' As mentioned in the background material to the
Council's policy, an annual vote would allow shareowners to
provide regular, timely feedback on the board's recent
executive pay decisions. And annual votes would allow companies
and their shareowners to gauge the trend in support for pay
decisions. So we do specify that the ``say-on-pay'' vote should
be annual and should be on senior executive compensation. But
our policy gives boards the flexibility to determine exactly
what disclosures should be covered by the vote (i.e., the
Summary Compensation Table by itself vs. the SCT plus
accompanying qualitative disclosures in the CD&A).
This was discussed in the background statement to our
``say-on-pay'' policy: ``While the push by investors for
shareowner votes on pay has made significant headway in a short
time, thoughts are still evolving on how best to implement the
reform. Therefore, the Council's draft updated policy endorses
the concept of advisory shareowner votes on executive
compensation, but stops short of dictating the precise contents
of such a vote.''
Q.2. How do we make sure boards can be an effective check on
management?
A.2. As noted by renowned corporate governance expert Nell
Minow, ``Boards of directors are like subatomic particles. They
behave differently when they are observed.'' The Council of
Institutional Investors believes boards would be a more
effective check on management if an overwhelming number of
directors are independent of management and if shareowners
could hold directors accountable for their performance. As a
result, the Council strongly supports mechanisms--including
majority voting for directors, advisory votes on executive
compensation and access to the proxy--that empower shareowners
to truly exercise their rights to elect and remove directors.
We believe federalization of these standards is appropriate
and indeed essential to the investing public. While the Council
appreciates that 50 governors, and likely many other self-
interested parties, oppose federalization of these basic
rights, the Council believes their opposition would be
overwhelmed by the support of the millions of U.S. citizens and
investors who have suffered profound losses from the many
market disruptions that have occurred in recent years,
including the dot-com bubble, the corporate scandals of the
early part of this decade, and most recently, the financial
crisis.
Q.3. How do we make sure boards and management know what is
going on inside the large firms they are supposedly running?
A.3. Robust, timely public disclosures are essential for
providing outside parties insights into the performance of
boards and management of large and small companies.
Since audited financial statements are a primary sources of
information available to guide and monitor investment
decisions, tough audit standards and strong accounting
standards are critical to ensuring that financial-related
disclosures are of the highest quality.
Auditors, financial analysts, credit-rating agencies and
other financial ``gatekeepers'' play a vital role in ensuring
the integrity and stability of the capital markets. They
provide investors with timely, critical information they need,
but often cannot verify, to make informed investment decisions.
With vast access to management and material nonpublic
information, financial gatekeepers have an inordinate impact on
public confidence in the markets. They also exert great
influence over the ability of corporations to raise capital and
the investment options of many institutional investors. Given
their power, the Council of Institutional Investors believes
financial gatekeepers should be transparent in their
methodology and avoid or tightly manage conflicts of interest.
Robust oversight and genuine accountability to investors are
also imperative. Regulators should remain vigilant and work to
close gaps in oversight. Continued reforms are needed to ensure
that the pillars of transparency, independence, oversight and
accountability are solidly in place.
Q.4. Is a better approach to making sure boards and management
understand what is going on inside their companies to shrink
the size and scope of the companies?
A.4. The Council of Institutional Investors has no formal
position on this issue. Regarding entities that may pose a
systemic risk to the financial system at large or the economy
at large, an independent task force, the Investors' Working
Group (IWG), cosponsored by the CFA Institute Centre for
Financial Integrity and the Council of Institutional Investors,
recommended that policy makers consider the following:
Designating a systemic risk regulator, with
appropriate scope and powers.
Adopting new regulations for financial services
that will prevent the sector from becoming dominated by
a few giant and unwieldy institutions. New rules are
needed to address and balance concerns about
concentration and competitiveness.
Strengthening capital adequacy standards for all
financial institutions. Too many financial institutions
have weak capital underpinnings and excessive leverage.
Imposing careful constraints on proprietary trading
at depository institutions and their holding companies.
Proprietary trading creates potentially hazardous
exposures and conflicts of interest, especially at
institutions that operate with explicit or implicit
Government guarantees. Ultimately, banks should focus
on their primary purposes, taking deposits and making
loans.
Consolidating Federal bank regulators and market
regulators. Regulation of banks and other depository
institutions may be streamlined through the appropriate
consolidation of prudential regulators. Similarly,
efficiencies may be obtained through the merger of the
SEC and the Commodity Futures Trading Commission
(CFTC).
Studying a Federal role in the oversight of
insurance companies.
IWG members strongly believed that all firms should be able
to fail. As a result, it recommended that ``Congress should
give regulators resolution authority, analogous to the Federal
Deposit Insurance Corporation's authority for failed banks, to
wind down or restructure troubled, systemically significant
nonbanks.''
Q.5. For proxy access, how large of a block of shareholders
should have to request that the item be included?
A.5. The Council endorses the following policy regarding
shareowner access to the proxy:
Companies should provide access to management proxy
materials for a long-term investor or group of long-term
investors owning in aggregate at least 3 percent of a company's
voting stock, to nominate less than a majority of the
directors. Eligible investors must have owned the stock for at
least 2 years. Company proxy materials and related mailings
should provide equal space and equal treatment of nominations
by qualifying investors.
To allow for informed voting decisions, it is essential
that investors have full and accurate information about access
mechanism users and their director nominees. Therefore,
shareowners nominating director candidates under an access
mechanism should adhere to the same SEC rules governing
disclosure requirements and prohibitions on false and
misleading statements that currently apply to proxy contests
for board seats.
Q.6. What are issues that shareholders should have an opt out
or opt in vote on?
A.6. The Council has no position on opt in/opt out votes for
shareowners. Council policies state that ``shareowners should
have meaningful ability to participate in the major fundamental
decisions that affect corporate viability, and meaningful
opportunities to suggest or nominate director candidates and to
suggest processes and criteria for director selection and
evaluation.''
In addition, the Council believes a majority vote of common
shares outstanding should be sufficient to amend company bylaws
or take other action that requires or receives a shareowner
vote. Supermajority votes should not be required. A majority
vote of common shares outstanding should be required to
approve:
Major corporate decisions concerning the sale or
pledge of corporate assets that would have a material
effect on shareowner value. Such a transaction will
automatically be deemed to have a material effect if
the value of the assets exceeds 10 percent of the
assets of the company and its subsidiaries on a
consolidated basis;
The corporation's acquisition of 5 percent or more
of its common shares at above-market prices other than
by tender offer to all shareowners;
Poison pills;
Abridging or limiting the rights of common shares
to: (1) vote on the election or removal of directors or
the timing or length of their term of office or (2)
nominate directors or propose other action to be voted
on by shareowners or (3) call special meetings of
shareowners or take action by written consent or change
the procedure for fixing the record date for such
action; and
Issuing debt to a degree that would excessively
leverage the company and imperil its long-term
viability.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM ANN YERGER
Q.1. One of the proposals you support, which is supported by
the Administration, is to allow advisory shareowner votes on
executive pay. How would a Government-mandated ``say-on-pay''
vote have prevented the current financial turmoil? How would a
government mandated ``say-on-pay'' vote prevent future
financial turmoil when, according to the American Federation of
State, County, and Municipal Employees, 23 companies have
allowed ``say-on-pay'' provisions to proceed to a vote and
shareholders have yet to vote down a single executive pay plan
in the U.S.?
A.1. The Council believes annual advisory shareowner votes on
executive compensation would efficiently and effectively
provide boards with useful information about whether investors
view the company's compensation practices to be in shareowners'
best interests. Nonbinding shareowner votes on pay would serve
as a direct referendum on the decisions of the compensation
committee and would offer a more targeted way to signal
shareowner discontent than withholding votes from committee
members.
While advisory votes might not have prevented the current
financial crisis nor might they prevent future financial
turmoil, they might induce compensation committees to be more
careful about doling out rich rewards, to avoid the
embarrassment of shareowner rejection at the ballot box. In
addition, compensation committees looking to actively rein in
executive compensation could use the results of advisory
shareowner votes to stand up to excessively demanding officers
or compensation consultants.
Historically, early ``volunteers'' for corporate governance
reforms tend to be companies with the best practices and hence,
nothing to fear from the reforms. As a result, I am not
surprised that shareowners supported the compensation proposals
of the 23 companies identified by AFSCME. Of the thousands of
other public companies, I expect some would find that their
owners do not support their compensation programs, and that
this vote will provide meaningful information to board and
compensation committees.
In addition to the 23 companies identified by AFSCME,
hundreds of financial firms receiving aid under the U.S.
Troubled Assets Relief Program (TARP) were required to put
their executive pay packages to an advisory shareowner vote.
And while some received large ``no'' votes, ``on average 88.6
percent of votes cast at 237 firms that have disclosed results
were in favor of management, according to an analysis by David
G. Wilson, a securities lawyer at Waller Lansden Dortch & Davis
who focuses on corporate governance matters,'' according to a
September 26, 2009, article in The Washington Post. While some
might attribute the high support votes to a failure of the
advisory vote concept, others might attribute the support
levels to the pay restrictions imposed on these firms by the
U.S. Department of Treasury and the 2009 Economic Stimulus Act.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM JOHN J. CASTELLANI
Q.1. Professor Coates raised an interesting idea in his written
testimony. Rather than forcing a structure on all companies, he
suggests an opt out vote by shareholders every few years for
some governance proposals. That idea could be applied to proxy
access and advisory vote procedures as well instead of the
Government deciding what the rules will be. I want to know what
you think of that approach, of a mandatory opt in or opt out
vote every few years to decide certain matters. Please also
comment on whether such a vote should be an opt in or opt out
vote.
A.1. Business Roundtable believes that shareholders and
companies should have the ability to make choices about the
governance practices that are most appropriate for their
circumstances. However, we do not believe that an ``opt in'' or
``opt out'' vote on different governance practices is
necessary. Shareholders already have the ability to communicate
their views on whether to adopt particular practices. They can
do this through the shareholder proposal process as well as
procedures that companies have implemented for shareholders to
communicate with the board as a whole and with particular
directors. For example, shareholders who believe an advisory
vote is necessary at their company can submit shareholder
proposals requesting such a vote. If other shareholders agree,
they can vote in favor of these proposals, and several
companies have implemented advisory votes after proposals on
this subject received significant shareholder support. Other
companies have taken different approaches to obtaining
shareholder views on executive compensation, such as holding
meetings with their large shareholders or obtaining shareholder
feedback through procedures that allow shareholders to
communicate with the board.
If Congress considers an ``opt in'' or ``opt out'' vote, we
believe that an ``opt in'' vote would be preferable. An ``opt
in'' vote would require shareholders to take the affirmative
step of voting ``for'' a specific governance practice before a
company adopts it, which in turn, would provide a more accurate
indication that a critical mass of shareholders favors the
practice.
Q.2. There has been a lot of talk about giving shareholders a
vote on pay packages, but little discussion of the details. If
we were to require such a vote, what specifically should be
voted on, and how often?
A.2. If Congress requires an advisory vote on executive
compensation, Business Roundtable believes that it should give
companies flexibility to structure the vote based on their
individual compensation programs and packages. There are a
number of approaches companies could use, and that companies
have taken to date, to seek input on executive compensation
through an advisory vote. For example, companies could ask
shareholders to vote on: (a) the executive compensation tables
in the annual proxy statement; (b) the company's compensation
philosophy and procedures as described in the Compensation
Discussion and Analysis section of the proxy statement; and/or
(c) particular aspects of a company's compensation program,
such as post-retirement benefits or long-term incentive plans.
In addition, there are different approaches companies could
take with respect to the frequency of advisory votes. Although
many have suggested an annual vote, other practices are likely
to emerge. For example, the United Brotherhood of Carpenters
Pension Fund has proposed that companies hold advisory votes
once every 3 years. Accordingly, Business Roundtable does not
believe that a ``one-size-fits-all'' Federal legislative
approach to advisory votes on executive compensation is
appropriate.
As an alternative to allowing companies and shareholders to
determine the specifics of advisory votes, Business Roundtable
believes that Congress should give the Securities and Exchange
Commission (SEC) authority to adopt rules addressing matters
such as the frequency of the vote requirement, its
applicability to particular businesses or types of businesses,
and the matter(s) to be voted on. This administrative
flexibility would allow the SEC to tailor the application of
voting requirements based on a range of factors and to make
changes over time. For example, the SEC proposed rules in July
2009 to help implement the advisory vote requirement in the
Emergency Economic Stabilization Act of 2008 applicable to
companies receiving funds under the Troubled Asset Relief
Program. As the SEC noted in proposing these rules, their
purpose is to provide clarity about how to comply with the
advisory vote requirement while at the same time affording
companies adequate flexibility in making relevant disclosures
about the vote.
Q.3. How do we make sure boards can be an effective check on
management?
A.3. Business Roundtable believes that an engaged and diligent
board of directors is the most effective mechanism for
overseeing management. One of the guiding principles in our
Principles of Corporate Governance (2005) states that ``the
paramount duty of the board of directors is to select a chief
executive officer and to oversee the CEO and senior management
in the competent and ethical operation of the corporation on a
day-to-day basis.''
We believe that the best way to provide for effective board
oversight is to continue to foster the long tradition of
addressing corporate governance matters at the State level
through private ordering by shareholders, boards and companies
acting within the framework established by State corporate law.
In this regard, the corporate governance landscape has
undergone a sea change over the past 6 years. Many of the
corporate governance practices implemented during this time--
such as greater independent board leadership and majority
voting in director elections--have occurred as a result of
voluntary reforms adopted by companies and their shareholders
under the auspices of enabling State corporate law provisions,
rather than through legislative or regulatory fiat. Moreover,
under State corporate law, directors have fiduciary duties
requiring them to act in good faith, in the corporation's best
interests, and to exercise appropriate diligence in overseeing
the management of the corporation, making decisions and taking
other actions. In this regard, there are consequences under
State corporate law, as well as the Federal securities laws,
for directors who fail to perform their responsibilities.
Q.4. How do we make sure boards and management know what is
going on inside the large firms they are supposedly running?
A.4. Business Roundtable believes that the most effective way
for a company's board and management to remain informed is for
the company to have effective processes for communicating
complete, accurate, and timely information to the attention of
the board and management. Information flow between the board
and senior management is critical, and well-functioning boards
foster an environment that promotes candor and encourages
management to bring potential issues to the board early so that
there are ``no surprises.'' Moreover, as we recommend in our
Principles of Corporate Governance (2005), a company's
nominating/governance committee should assess the reporting
channels through which the board receives information and see
that the board obtains appropriately detailed information in a
timely fashion. In situations where specialized expertise would
be useful, the board and its committees should seek advice from
outside advisors who are independent of the company's
management. In addition, it is senior management's
responsibility--under the direction of the CEO and CFO--to
establish, maintain and periodically evaluate the
corporation's: (a) internal controls (controls designed to
provide reasonable assurance about the reliability of the
company's financial information) and (b) disclosure controls
(controls designed to see that a company records, processes and
reports information required in SEC filings in a timely
manner). In accordance with applicable law and regulations, the
CEO and CFO also are responsible for certifying the accuracy
and completeness of the financial statements and the
effectiveness of the company's internal controls and disclosure
controls.
Q.5. Is a better approach to making sure boards and management
understand what is going on inside their companies to shrink
the size and scope of the companies?
A.5. Business Roundtable does not believe that this is a better
approach, nor is it consistent with the traditional U.S.
approach to encouraging a vibrant private sector. Well-
structured and well-governed companies have the ability to deal
with the size and scope of their businesses because they have
solid information flow between the board and management and
they maintain effective internal controls.
Q.6. For proxy access, how large of a block of shareholders
should have to request that the item be included?
A.6. Business Roundtable believes that a Federal proxy access
right is unnecessary and would have serious adverse
consequences, including promoting an unhealthy emphasis on
short-termism at the expense of long-term value creation,
facilitating the election of ``special interest'' directors,
increasing the frequency of contested elections and
discouraging qualified directors from serving on corporate
boards. Therefore, we do not support a Federal proxy access
right. If Congress moves forward in this area, Business
Roundtable believes that proxy access should be available only
to holders of a significant, long-term interest in a company.
Accordingly, we believe that the stock ownership threshold for
individual shareholders seeking to place nominees on company
proxy statements should be 5 percent of a company's outstanding
voting stock and that the threshold for shareholders
aggregating their shares should be 10 percent. In either case,
a ``net long'' ownership position--that is, full voting and
investment power with respect to the shares in question--should
be required.
In addition, we believe that proxy access should be
available only to shareholders who have demonstrated a
commitment to a company and its business. Accordingly, we
believe that shareholders should have to satisfy the relevant
stock ownership threshold for a period of at least 2 years
before they can nominate a director for inclusion in the
company's proxy statement. Any shorter holding period would
allow shareholders with a short-term focus to nominate
directors who, if elected, would be responsible for the
creation of long-term shareholder value. In addition, we
believe that shareholders should have to continue to satisfy
the relevant ownership threshold not just through the annual
meeting at which their nominees are elected, but for the
duration of the nominees' service on the board or at least
through the term for which they nominated the director.
Q.7. What are issues that shareholders should have an opt out
or opt in vote on?
A.7. As discussed above in the answer to Question 1, we do not
believe that an ``opt in'' or ``opt out'' vote on different
governance practices is necessary because shareholders already
have the ability to communicate their views on whether to adopt
particular practices. As an alternative to this approach,
Business Roundtable supports enhanced disclosure about
companies' corporate governance practices. For example, the SEC
recently proposed rules that would require annual proxy
disclosure about a company's leadership structure and why the
company believes it is the best structure for the company,
including discussion about whether the company combines or
separates the roles of chairman of the board and CEO and
whether the company has a lead independent director. Similarly,
Business Roundtable would support a ``comply or explain''
approach, which some non-U.S. markets already follow, that
would require companies to disclose whether they have adopted
specific governance practices, and if not, why not. Either of
these alternatives would allow companies and shareholders
flexibility in determining the practices that are most
appropriate for them, provide transparency to shareholders and
avoid a ``one-size-fits-all'' approach.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM J.W. VERRET
Q.1. Professor Coates raised an interesting idea in his written
testimony. Rather than forcing a structure on all companies, he
suggests an opt out vote by shareholders every few years for
some governance proposals. That idea could be applied to proxy
access and advisory vote procedures as well instead of the
Government deciding what the rules will be. I want to know what
you think of that approach, of a mandatory opt in or opt out
vote every few years to decide certain matters. Please also
comment on whether such a vote should be an opt in or opt out
vote.
A.1. Answer not received by time of publication.
Q.2. There has been a lot of talk about giving shareholders a
vote on pay packages, but little discussion of the details. If
we were to require such a vote, what specifically should be
voted on, and how often?
A.2. Answer not received by time of publication.
Q.3. Are States responding to concerns about corporate
governance issues with changes to their own laws? Is there
really a need to federalize business laws?
A.3. Answer not received by time of publication.
Q.4. How do we make sure boards can be an effective check on
management?
A.4. Answer not received by time of publication.
Q.5. How do we make sure boards and management know what is
going on inside the large firms they are supposedly running?
A.5. Answer not received by time of publication.
Q.6. Is a better approach to making sure boards and management
understand what is going on inside their companies to shrink
the size and scope of the companies?
A.6. Answer not received by time of publication.
Q.7. For proxy access, how large of a block of shareholders
should have to request that the item be included?
A.7. Answer not received by time of publication.
Q.8. What are issues that shareholders should have an opt out
or opt in vote on?
A.8. Answer not received by time of publication.
Q.9. Please provide any comments you may have on the proposed
Shareholders Bill of Rights Act, S. 1074, or otherproposed
legislation.
A.9. Answer not received by time of publication.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM J.W. VERRET
Q.1. Professor, in your testimony you suggest alternative
contributing factors for the Committee to investigate to
determine the ``culprit'' of the financial crisis. The first
factor you suggest to investigate is the moral hazard problems
created by the prospect of the Government bailout. Do you think
that moral hazard problem is stronger cause of the than
corporate pay structure? Do you think the distortions to the
housing market cause by Fannie Mae and Freddie Mac played a
larger role in causing the financial crisis of 2008 than how a
company pays its CEO?
A.1. Answer not received by time of publication.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM RICHARD C. FERLAUTO
Q.1. Professor Coates raised an interesting idea in his written
testimony. Rather than forcing a structure on all companies, he
suggests an opt out vote by shareholders every few years for
some governance proposals. That idea could be applied to proxy
access and advisory vote procedures as well instead of the
Government deciding what the rules will be. I want to know what
you think of that approach, of a mandatory opt in or opt out
vote every few years to decide certain matters. Please also
comment on whether such a vote should be an opt in or opt out
vote.
A.1. The proxy access procedure that has been proposed by the
SEC aims to remove regulatory barriers to shareholders'
exercise of their existing rights to nominate director
candidates. It facilitates shareholders' use of their
nomination rights by recognizing that in the modern system of
proxy voting, the proxy statement itself is the forum that used
to occur at the shareholder meeting. Accordingly, the proxy
access procedure is a disclosure measure, rather than a new
substantive right. \1\
---------------------------------------------------------------------------
\1\ I acknowledge that there are some who argue that section 14(a)
of the Exchange Act does not authorize the Commission to propose a
proxy access procedure. Although I believe that the Commission's
authority is clear in this regard, an explicit legislative grant of
authority would be useful in order to avoid unnecessary litigation and
provide some measure of stability in this area.
---------------------------------------------------------------------------
For that reason, I don't believe it would be appropriate
for companies to opt in or opt out of the proxy access
procedure. In the same way that companies are not permitted to
opt out of the application of the SEC's shareholder proposal
rule or the executive compensation disclosure requirements,
they should not be allowed to opt out of the proxy access
procedure.
Of course, a company should be able to provide its
shareholders with a more shareholder-friendly form of access
procedure than that established by the SEC's proposed rule. For
example, a company could provide that holders of a lower
percentage of outstanding shares are entitled to invoke the
proxy access procedure, or it could allow nominating
shareholders to include longer supporting statements than the
SEC's rules contemplate.
The shareholder advisory vote on executive compensation
does not primarily address disclosure, and thus stands on
different footing. My main concern about a regime in which
``say-on-pay'' would not apply to companies for some period of
time is that it imposes significant delay on the process of
obtaining shareholder voice, should shareholders believe that
such voice is needed to safeguard shareholder value.
For instance, one could imagine a regime that would provide
for a vote of one kind or another every 3 years. At a company
without ``say-on-pay'' where performance begins to suffer
shortly before the scheduled vote, but it does not become
apparent that the pay-performance relationship has been severed
until shortly after the vote, shareholders might have to wait
almost 3 years to vote in favor of applying or reinstating
``say-on-pay.'' As Bob Pozen, formerly of Fidelity, stated in
criticizing the triggering requirements of the SEC's 2003
proposed proxy access procedure, ``two years is an eternity in
this game.'' \2\
---------------------------------------------------------------------------
\2\ See ``The Debate on Shareholder Access to the Ballot, Part I''
(transcript of symposium at Harvard Law School in October 2003), at 46
(available at http://www.law.harvard.edu/programs/olin_center/
corporate_governance/papers/03.bebchuk.debate-1.pdf).
---------------------------------------------------------------------------
In any event, the collective action problem facing
shareholders, which has been exhaustively analyzed in the
academic literature, argues in favor of an opt out procedure
rather than an opt in procedure. The weight given to
management's recommendations on proxy issues--the opt in or opt
out proposal would be a management proposal, presumably--the
well-documented expense and difficulty attendant to shareholder
communication and the vote-boosting effect of the New York
Stock Exchange's ``broker-may-vote'' rule on management
proposals all argue in favor of making applicability of a
governance feature the default, and requiring management to
convince shareholders that the company is so well-governed that
the governance feature would not be value enhancing.
Q.2. There has been a lot of talk about giving shareholders a
vote on pay packages, but little discussion of the details. If
we were to require such a vote, what specifically should be
voted on, and how often?
A.2. As proposed in H.R. 3269, the Corporate and Financial
Institution Compensation Fairness Act of 2009, shareholders
should be given the opportunity to vote on ``the compensation
of executives as disclosed pursuant to the Commission's
compensation disclosure rules for named executive officers
(which disclosure shall include the compensation committee
report, the compensation discussion and analysis, the
compensation tables, and any related materials, to the extent
required by such rules).'' This vote should occur annually.
Q.3. How do we make sure boards can be an effective check on
management?
A.3. Many factors have an impact on board effectiveness,
including the skills, qualifications, and experience of
directors; the independence and vitality of the board's
leadership; and the quality of the information and advice
provided to the board. However, the single most important
factor determining whether the board can and will effectively
oversee management is whether board members feel they work for
the shareholders. If shareholders do not have a meaningful role
in nominating and electing directors, they will not engage in
robust monitoring. As Relational Investors' Ralph Whitworth has
said, ``you dance with who brought you.'' \3\ Accordingly,
measures such as proxy access that enable shareholders to more
fully exercise their State-law right to nominate directors
would be very useful in improving board effectiveness.
---------------------------------------------------------------------------
\3\ See, id. at 41.
Q.4. How do we make sure boards and management know what is
---------------------------------------------------------------------------
going on inside the large firms they are supposedly running?
A.4. Keeping boards and managements informed enough to do their
jobs well requires different strategies. Members of management
are employees of the company and devote themselves full-time to
its management. The right reporting and information structures
to ensure that senior managers are aware of what is happening
will vary tremendously from one company to another, depending
on the nature of the company's business, the geographical reach
of its operations and other factors. As a result, it is not
possible to prescribe a single structure that works well for
all companies.
Boards of directors, by contrast, are composed primarily of
people from outside the company and they meet to work on
company business only periodically. Many board members have
demanding day jobs; those who do not are often members of
multiple boards or engage in philanthropic or other pursuits
that take significant time and attention. Accordingly,
information must be collected and synthesized before
presentation to the board, in order to use directors' time
efficiently.
It is important that a company's senior management not have
a monopoly on the flow of information to the board; if it does,
the board functions more as a rubber stamp than as an effective
monitor and resource. Independent board leadership is the best
way to ensure that directors have access to all the information
they need to do their jobs well. An independent board chairman
sets the agenda and provides relevant information to directors;
he or she will include material furnished by members of senior
management but will also be able to provide outside
perspectives. Where the chairman is also the CEO, by contrast,
his or her perspective will dominate and outside information is
less likely to be provided to board members.
Q.5. Is a better approach to making sure boards and management
understand what is going on inside their companies to shrink
the size and scope of the companies?
A.5. It is possible that a company's operations may become too
large, varied, and dispersed for adequate monitoring to be
cost-effective. In the vast majority of cases, however, I
believe that the mechanisms discussed in response to Questions
3 and 4 will address the problem of ensuring robust oversight.
Q.6. For proxy access, how large of a block of shareholders
should have to request that the item be included?
A.6. The thresholds proposed by the SEC in its current rule
making strike the right balance between ensuring that the
access procedure is available only to shareholders with a
substantial stake in the company and fulfilling the objective
of removing obstacles to the exercise of shareholders' State-
law director nomination rights.
Q.7. What are issues that shareholders should have an opt out
or opt in vote on?
A.7. I do not favor, in the first instance, an opt in or opt
out regime for the governance reforms discussed at the hearing.
As discussed in the answer to Question 1, an opt in or opt out
process is not appropriate for disclosure measures. For other
reforms, my support of an opt out regime would depend on how
often the vote was held and whether shareholders could quickly
trigger an earlier vote if circumstances warranted.