Archive for the ‘Shareholder Accountability’ Category

Executive compensation is broken: Three ways to fix it

President Obama said to a reporter recently, “We have corporate governance that allows CEOs to pay themselves ungodly sums.”

Why should this be the case, and how might this problem be addressed?

Following say on pay protests in Canada at CIBC, Barrick Gold and Yamana Gold, and others at BP, HSBC and JP Morgan, the Securities and Exchange Commission (SEC) recently proposed rules linking pay to performance, six years after Congress passed the law directing them to so in the first place.

Will the new rules work? Regulators have a poor track record of getting executive pay right. Indeed, some say Congress has been the single greatest driver of increasing CEO pay.

According to a survey by Mercer, a majority of UK board members believe the executive pay model is broken. Here are three ways to fix it.

First, look at who is negotiating the pay. A CEO pay contract is negotiated between a subset of company directors – the compensation committee – and the CEO. I remember a CEO telling me once, “I will out-gun any compensation committee.” He is right. For any contract to work, there needs to be proper motivation and equality of bargaining power. Many directors on pay committees are former CEOs, have been on the board for over nine years, or tend to be men recruited on the basis of prior relationships. These types of directors are not effective in negotiating a CEO pay contract.

Directors confide to me how perks compromise them, including jobs for acquaintances, gifts, vacations, and so on. There is no free market for CEO pay if the people on the other side of the table are captured.

An effective bargaining party should be independent of management and selected directly by shareholders to represent investor interests. In other words, shareholders should be selecting the directors, not directors and certainly not management.

I advise large investors that they should press for this right to select directors. Industry Canada is considering corporate reforms, and should give shareholders the right to select and remove directors without artificial barriers. In the Canadian companies above, not a single director on the compensation committees was forced to resign, including the compensation committee chair on the Quebecor board who failed to garner majority support.

Second, CEO pay has been driven upwards by a process known as “peer benchmarking.” Invented by pay consultants, one CEO’s pay is compared to pay of other CEOs, often at larger, complex companies (“peers”). Compensation committees, who purchase this comparative data, want to pay their own CEO, not at a 50th percentile (meaning that half of CEOs are better than their CEO), but at the 75th or 90th percentile. This inflationary effect, as you can imagine, has resulted in structural increases to CEO pay. Research confirms this. The process is made worse by rivalry, because CEOs see what other CEOs are earning, and think they deserve more. This knowledge and mindset increases the leverage of the CEO during pay negotiations.

One public sector organization, about to disclose pay for its employees, whom I recently advised, is not disclosing the identity of employees and their pay, but only the position title. This pay disclosure promotes good governance and accountability, but addresses peer rivalry, privacy and safety concerns. More regulators should exercise care over the inflationary results of disclosing pay. Compensation committees should focus less on inter-company comparison, and more on the performance and value creation within their company.

This brings me to the final pay reform, which is linking pay to sustained value creation within the company over the longer term. Performance metrics are what drives management. Most performance metrics for executive pay are short-term, financial, and based on total shareholder return (TSR). Even the new SEC rules rely on TSR. Research shows, however, that much of TSR is not under the control of management, but rather reflects exogenous market forces. In other words, executives benefit from factors beyond their control, such as a bull market.

Most of the business model and market value of companies are composed of broader, leading indicators that are non-financial in nature. By focusing just on financial results, boards lack the ability to track leading indictors, which could be customers, reputation, employees, innovation, R & D, ethics, risk management, safety, and so on, that measure risk and broader performance. Many boards desire these metrics but they are under-developed by management, which reflects board complacency.

90% of pay is short term, which is fewer than three years. This short-term focus causes executives to swing the fences for short-term gains, taking risks, because their pay incents them to do so, rather than being aligned with the product cycle of the company, which is in the range of five to seven years.

International Monetary Fund chief, Christine Lagarde, has called for banks to change the culture of short-term risk taking. There is also director leadership responding to short-termism: The subject of the Institute of Corporate Directors conference next month is titled “Short-Termism: A Problem or Not.”

The problem is that opposing the above reforms – shareholders selecting compensation committee members; relying less on peer benchmarking; and relying more on broader long-term performance metrics – are so entrenched into the status quo and vested interests that these reforms are almost unachievable. CEO pay problems will continue. To truly solve this issue, more leadership is needed from investors and directors. Models and best practices are needed to devise roles for shareholders in selecting directors and long term pay principles. Thoughtful regulation and more industry leadership and cooperation are needed.


The Corporate Governance Game Changer That Needs to Come To Canada

I teach my students and counsel board clients that shareholders elect directors; directors appoint managers; directors are accountable to shareholders; and managers are accountable to directors. This is largely theoretical.

Here is the reality: Shareholders: (i) cannot select directors; (ii) cannot communicate with directors; and (iii) cannot remove directors, by law, without great cost and difficulty. Therefore, directors are largely homogenous groups who are selected by themselves, or, worse yet, management.

Addressing the foregoing is the one piece of reform that will change corporate governance and performance for the better. The rest is, as they say, window dressing.

I have encouraged institutional investors and regulators to consider advocating what is known as “proxy access.” This means that a shareholder, or a group of shareholders, who (i) own a modest, minimum threshold of shares (say 3%, although the percentage could be higher or lower, or floating, depending on the size of the company); (ii) for a period of time (say 3 years, although the time period could be shorter); (iii) can select up to 25% of proposed directors, of the total board size, in an uncontested election (meaning a change of control is not desired by the shareholders) in a given year.

When shareholders “select” their nominees for the board, these directors would be alongside, in the management proxy circular, in alphabetical order, with profile parity (short bios and areas of competency), the management slate of directors. Management would be obliged to include shareholder-nominated directors, at a cost to the company, not shareholders, if the above ownership and time requirements are met. There would be no costly proxy battles or dissident slates. There would be no undue influence by management to marginalize shareholder-nominated directors within or outside of the proxy. Rules of the road will be set.

Then, shareholders get to decide, as they should, on the best directors from among the management-proposed and the shareholder-proposed directors. Ideally, the selection should be as blind or neutral as possible. The focus should be solely on the qualifications, competencies and track record of the proposed directors for election at that company. May the best directors win, as should be the case in any election, versus a slate of management-nominated directors, which is the case now. Under this new regime, there will be winners and losers. The practical effect may be that legacy or unqualified directors may withdraw from this scrutiny, as Canadian Pacific directors did at the time of shareholder Pershing Square’s involvement. This is not an undesired outcome and creates a market for the most qualified directors to rise to the top.

When proxy access was proposed by the Securities and Exchange Commission (SEC) in the US, management and lawyers who work for management used shareholder money to fight proxy access proposed under Dodd Frank, and won in the US Court of Appeals, on the basis of an inadequate cost benefit analysis. (Canadian investors and regulators should learn from this experience.) Proxy access now is left to companies on a one-off basis, rather than being system wide. Meaningful proxy access has only occurred at a small number of companies as a result. The SEC should revisit proxy access. Industry Canada is currently looking at implementing proxy access at the 5% level for all federally incorporated companies.

Opponents to proxy access argue that shareholders selecting directors will propose special purpose directors or directors who lack the background or experience. The evidence is the opposite. Shareholders are better at proposing directors who have the shareholder track record and industry expertise that the current board lacks. Recall Canadian Pacific, where not a single director possessed rail experience prior to shareholder involvement. There are other examples at Hess, Office Depot, Darden, Bob Evans, Abercrombie and Occidental Petroleum (see Field Experience Helps Win Board Seats), where shareholder-advocated directors were either better than incumbent ones, or caused the renewal of management-advocated ones. A director qualification dispute is welcome and will focus the lens on competencies of directors, including industry expertise, which is a good thing. Ann C. Mule and Charles Elson report in “Directors and Boards” that “One study concludes that more powerful CEOs tend to avoid independent expert directors.”

Herein lies the real resistance to proxy access: Management does not want it, and, the record shows, will fight vigorously to resist it. Management-retained advocates hired to oppose proxy access should disclose whom their client is. Directors however, when deciding to support proxy access, or not, should not be beholden to management, nor their advisors, nor act out of self-interest in entrenching themselves, but should be guided only by the best interests of the company, including its shareholders. There is evidence that the market values strong proxy access positively, leading to an increase in shareholder wealth. If a director possesses the independence of mind, and the competency and skills to serve on the board, they should welcome proxy access. It will mean that the under performing directors on the board will be ferreted out, and current directors can avoid this uncomfortable task. Shareholders and the new competitive market for corporate directors will do it for them.

Richard Leblanc: Ten Corporate Governance Trends for 2014

1.         Active owners focused on performance. Expect pressure by activists and institutions for boards to control under-performing management to continue unabated. Boards incapable or unwilling to rein in inefficiencies, improper capital allocation, asset mismanagement, or operational improvements will be targets. Directors whose skills do not support value creation; and ossification, complacency and atrophy more broadly, will also be targets.

2.         Shareholder accountability: Expect greater direct communication between boards and major shareholders, with “listening” mode and restricted management access continuing. Look also for pressure on asset owners themselves, by investee companies, for engagement transparency, protocols and disclosure. Expect proxy access demands by investors to continue; management and retained advisor resistance to it; and potential regulation enabling it in the future.

3.         Regulation. Continued widespread regulation targeting boards will continue. Industry Canada is contemplating governance reforms in 2014 or beyond. In the US, pay for performance, clawbacks, pay ratios, and proxy advisory regulations are likely in 2014.

4.         Director and auditor entrenchment. Expect pressure for board renewal and auditor rotation to continue in 2014. This will take the form of tenure limits, caps on directorships, diversity legislation, director and auditor evaluation, and mandatory requests for audit tender. Expect continued resistance by incumbent directors and the big 4, but expect also shareholder pressure and regulation to overcome.

5.         Cybercrime and other operational and reputation risks. Expect lawsuits targeting boards for data breach and investor loss at Adobe, Skype, Target, Neiman Marcus and Snapchat that precipitate governance enhancements. Expect greater risk regulation and spends for financial service companies and non-banks. Many boards and management have immature risk management, deficient – or at times non-existent – controls over IT, operational, and reputation risks. Look for efforts by good boards to have risk expertise on the board; internal oversight functions and third party reviews reporting to the board; and assurance over the entire risk appetite framework. Expect lawsuits and increasing regulation for the laggards.

6.         Focus on longer-term value creation. Expect asset owners to exert pressure on directors and asset managers to develop long-term metrics commensurate with the product and risk cycle of the company. Pay metrics such as health, innovation, culture, R and D, etc. will drive long-term investment. Look for “integrated” reporting and metric maturity in 2014 and 2015, making it easier for corporate boards to direct long-term non-financial incentive pay and investment.

7.         Focus on the Board Chair. Expect greater movement to non-executive Chairs from Lead Directors in the US, and Chair position maturity in other Anglo-American countries. Look for rigorous roles and responsibilities of board chairs developing, beyond formal independence, including driving value creation and company performance for investors.

8.         Greater clarity on pay for performance. Look for guidance by the SEC, including on realizable pay. Expect movement from short term, quantitative, financial pay metrics to long term, non-financial, qualitative, multi-year return metrics, and pay that adjusts for risk and performance over the longer term, with greater discretion to compensation committees and boards – and if necessary shareholders.

9.         Tightening up of independence standards. Look for boards to tighten up independent standards over lawyers, compensation consultants, auditors, and themselves, to arrive at “non-conflicted directors getting non-conflicted advice.” Look for scrutiny over soft management influence and capture over all of the above. Expect continued regulation if or when boards resist.

10.       Greater focus on culture, whistleblowing, tone in the middle, and anti corruption. Expect good boards to go beyond the CEO to scrutinize compensation of “risk takers” anywhere in the organization; share the hiring, firing and compensation decisions for risk, internal audit, compliance and the CFO; and receive assurance and reporting over all material risks and controls. CEOs (or any operating or senior management) who block or are not transparent should be regarded as red flags.

Richard Leblanc is a governance lawyer, academic, speaker and independent advisor to leading boards of directors. He can be reached at or followed on Twitter @drrleblanc.

Discussion notes for Corporate Secretary Think Tank Canada Panel, 2 October 2013: Panel: Shareholder Activism, 9:30-10:45am

There have been a number of activist situations in Canada recently, including CP, Agrium, Telus, BlackBerry, Tim Hortons and others. Is your board a siting duck or otherwise vulnerable? Here is what the red flags are for defective governance, below.


The following reflects, in no particular order: (i) my work in advising regulators (e.g., OSFI, OSC, AGCO, FiCom, others) in respect of governance; (ii) interviews with 40 activists, private equity leaders, members of the NACD 100, and top 100 CEO listing in 2013; (iii) my advisory work in two activist situations above (both advising the activist in the first, and board under attack in the second); (iv) my work with governance enhancements in companies that have been accused of fraud, bribery, corruption, stock manipulation and otherwise (ten in total); and (v) my advising and assessing award-winning boards (nine in total), who have strengthened their governance. The data collection has included individual director interviews and observing the board in action. For the full paper, published in the International Journal of Disclosure and Governance, November 2013, Special Issue: Enhancing the Effectiveness of the 21st Century Board of Directors: Part II, edited by myself, please contact me and I will email it to you.

Governance red flags, for activist attack and board bulletproofing, especially board composition, leadership, value creation and compensation, include the following, in no particular order

1. Captured, owned directors (trips, gifts, friends, company office, interlocks, school together, jobs for kids, donations, Directors economically dependent on fees): not objectively independent and/or owned in the boardroom, and Board refuses to have heightened independence standards or address the foregoing;

2. Directors with reputational, adverse publicity, integrity, independence, other board performance, egregious action or failure baggage, or inadequate experience and track record, and Board does not cure the distraction or adverse inference (i.e., promptly remove the Director);

3. No or little industry (market / geography, customer, supply chain) expertise on Board, and Board incapable of providing strategic control and direction to Management;

4. Legacy, pedigree, over-boarded (>2), over-tenured (>9 years), or otherwise ‘zombie’ Directors without new blood, diversity and renewal. Evidence is: busy boards with busy directors (>2 boards) “consistent and convincing” worse long-term performance and oversight (Stanford researchers); >9 years directorship reduces firm value (“board tenure has an inverted U-shape relation firm value” – Huang, July 2013); and gamed majority voting returns ‘zombie’ director to board. Global regulatory director tenure converging on 9-10 years (UK, India, Australia, Hong Kong, Singapore, other). Management-beholden, cozy, over-tenured, or legacy service providers (law, audit, compensation): no renewal or freedom to be adverse: regulators now addressing;

5. Management who unduly influence independent oversight functions (internal audit, chief risk officer, chief compliance officer, chief actuary, or equivalents) or external assurance advisors (external audit, governance lawyer, compensation consultant, search firm) from Board or Committee oversight, by preselecting, starving or otherwise unduly influencing. Regulators are becoming clear these functions are to be independent of senior and operational Management, and accountable to the Board and/or relevant Committee directly;

6. Weak, legacy, not independent, not effective, or unskilled Chair (Board or Committee): specifically, a Chair owned by Management or a dominant Shareholder, or both, or who does not understand obligations, capital markets, lacks leadership, credibility, cannot implement strict management accountability standards, and lacks subject matter or industry expertise; A Chair who should not be Chair, in other words;

7. A Board Chair who cannot lead value creation: An activist Board does the following:

  • Board, led by Chair, sets standards for vigorous value creation process, establishes ambitious value creation criteria, and leads Management to develop optimal value creation plan;
  • Deep dives and due diligence by all Directors into company, business model, industry and markets to understand value drivers, innovation opportunities and associated risks;
  • Board approves plan and its milestones, monitors progress regularly, calling for prompt corrective action to ensure goals are met, including increased goals as new unplanned/unanticipated opportunities arise;
  • Value maximization plan clearly and simply spells out key timelines, milestones, targets, and individuals accountable for each key plan component and specific results;
  • Reporting format and information flow provides frequent, timely and accurate information to Board on plan progress and any variances;
  • Board addresses plan variances quickly and directly: Management provides concrete responses on how shortfall will be corrected, by whom and when;
  • Chair adopts a primary role in foregoing;
  • Maintenance of ‘day to day’ management by CEO and rest of executive team;
  • Highly engaged level of functioning by Board and a shift in primary focus towards value creation; and
  • Robust debate and review of plan execution is primary board meeting agenda item; and at least one presentation each board meeting from key personnel below the senior level, on that particular individual’s role in the value maximization plan and a full discussion of progress to date in that regard.

9. CEO and other management information/personnel funneling, channel blocking, and starving of the Board; a weak Chair who does not cure; buy-in to “nose in fingers out” drinking of the Kool-Aid promulgated by Management and even director associations (see item 8 above), without an activist Director who can move the room;

10. Lack of executive/in camera sessions without any Management (including General Counsel / Corporate Secretary) in the room (i.e., executive sessions of and with: the Board; each Committee; each independent oversight function (see item 6); each external assurance provider (item 6); and key Shareholders, without Management);

11. Lack of regular meetings with Directors and major long-term Shareholders, and Board Chair directing counsel not to interfere; and failure of Board to understand/appreciate, or be misinformed about, shareholder base, and their concerns, behaviors, styles and preferences, including dissident activity by insurgents and activists: no early warning system or rapid response, experienced fight team, and being caught flat-footed;

12. Not listening to, or acting upon, advisory, precatory or withhold proposals, resolutions, votes, the will of shareholders, or listening to advisors, or having conflicted advisors, and curing the underlying issue(s) promptly;

13. Lack of value creation plan, with focus on innovation or strategy by the Board, or a separate board Committee if the Board cannot or will not (see item 8 above for what this looks like);

14. Lack of confidence in Directors by investors: A board incapable or unwilling to direct, control or replace underperforming, ineffective or inefficient Management;

15. An arrogant, insulated, bloated, complacent, non-introspective, defensive, clubby or otherwise inexperienced board that is in denial, not in charge, has lost objectivity, is not credible, does not have a sense of urgency, cannot be relied upon, and/or has become entrenched;

16. A governance analysis by a Board that is not at least equal to that of the activist, who bases theirs on public (not inside) information;

17. Directors who are ‘paid for showing up’ (per meeting, per committee, flat fee, etc., or excessively paid) without incentive link from their pay (cash and equity) to individual performance and/or achieving company value creation hurdles; and spending Directors’ own money on stock, vs. being awarded stock for attendance (current);

18. Boilerplate, inadequate, complex or gamed disclosure;

19. Failure to appreciate the sophistication, resources, screening, homework, PR, signaling, persuasive ability, staying power and resolve of an activist to go the distance;

20. A Board allowing Management to become emotional and attack the activist, rather than focus on the value creation plan, the issue(s), and communicating this to Shareholders to win support, or compromise, or resolve with the activist (as the case may be);

21. A Board itself becoming defensive to reasonable governance enhancements or significant reform: going dark, lawyering up, engaging in window dressing, di minimis action, and/or siding with Management at the expense of the Company and Shareholders (as the case may be), thinking the issue will go away; or acting in the best interests of company as pretext for perceived self interest;

22. Entrenchment: Non reasonable pills, staggered, dual, super, restrictions, thresholds, advance notice, bylaws, etc., devised by incumbent Management counsel, approved by Board, and perceived to hide, block or frustrate fluid market for corporate control and/or director removal;

23. Advocacy and funding of trade associations, advisors, lobbyists to resist governance reform (using Shareholder money by self-serving Management is the view of some activists);

24. Inadequate attention to validating (and on occasion misrepresenting) each Director’s expertise: in other words, linking the strategy and value creation plan of the Company to each Director’s separate competencies;

25. Not countering the expertise and track record of each incumbent Director on the Management slate vs. each prospective Director on the dissident slate, removing any weak Director on Management slate where necessary: in other words, not countering the activist two part concerns that: (i) change is necessary, and (ii) the activist Director slate can more effectively address the change;

26. Management hubris, herding, empire building, going beyond pure play, poor capital deployment or cash oversight, asset or supply chain mismanagement, deficient operating, financial or strategic performance, or running out of options, and Board not owing the best ideas for unlocking of shareholder value before the activist does, with the Board being perceived as “enthusiastic amateurs” (large institutional shareholder CEO, from interviews);

27. Over-reliance on inflated peers and hyper benchmarking, (salary-disguised, non stretch bonuses, LTIP not performance-based (PSUs)), and 17% of CEO pay unrelated to performance rather than structural result of year-over-year above-median peer group pay (Elson and Ferrere, August 2012);

28. Excessive compensation equity to management: mixed relationship to performance, tendency to manipulate, and a Board moving goalposts;

29. Lack of proper independent governance treatment and disclosure of waste, conflicts of interest, related party transactions, complex structures, use of corporate opportunity, and extraction of Shareholder money to founder, family or insider, and sleepy Board;

30. Lack of integration of academic research: Recent disclosure in reference to 1994 Dey guidelines: “We did virtually no research.”; and

31. Board or retained management advisors that subscribes to the myth, or do not confront the evidence, that hedge fund interventions do not create long term positive operating performance and value for all shareholders, when systemic study shows they do (Bebchuk, July, 2013: analysis of 2000 interventions over 1994-2007 studied @ 5 year periods).

Richard W. Leblanc, PhD




The new US CEO to worker pay ratio and vested interests

The US Securities and Exchange Commission announced this week that public companies will be required to disclose the ratio of the annual total compensation paid to their CEO against compensation of that of the median worker, in the form of a ratio (e.g., 200 to one). See the proposed rule, here. One consultant estimated in a guest lecture for me that ratios could be as high as 1,000 to one. (See a list of eight companies apparently with this ratio, here.)

Other compensation consultants and lawyers have commented on the new CEO to median worker pay ratio. Advisors warn about the “law of unintended consequences” in this ratio, and how societal wealth disparity should not be laid on the doorstep of companies.

Let me fault the law of unintended consequences and wealth disparity at the doorstep not of companies but of the advisors themselves.

What happens with disclosure of pay data is revenue streams for pay advisors to boards. “Peer groups” and “benchmarking” – which is how most public company CEOs are paid – are inventions of compensation consultants. So are stock options. These concepts did not exist prior to Congress mandating greater pay disclosure.

“Peer groups” is a basket of similar or larger companies compared to one company, and “benchmarking” is a decision to pay a CEO at the 50th, 75th or 90th percentile of other CEOs. It is not in any executive’s interest to be paid compared to CEOs at smaller or less complex companies, nor to be paid as a ‘below average’ CEO, even though by definition 50% of CEOs must be below average.

This one issue – benchmarking against peer groups – has been responsible for CEO pay increases more than any other. Other academics have found that using benchmarked peer data in the above fashion results in a 17% structural year-over-year increase in CEO pay, that is unrelated to the CEO’s actual performance. This structural advantage, compounded annually, has caused the wealth disparity between CEOs and the average worker.

The pay consultants may be grinning behind closed doors because the above pay ratio will provide further built-in annuities for their firms beyond peer benchmarking and say on pay. What I predict is that compensation consultants and lawyers will do the following:

(i)             Assist companies in determining and interpreting their ratio (revenue stream number one);

(ii)           Sell the data back to companies to compare and explain ratios among their peers on an industry-by-industry basis, because average worker compensation for Bank of America will be different than that of Apple, for example (revenue stream number two); and

(iii)          Sell the data to labor groups to assist them in collective bargaining (revenue stream number three).

What happens with disclosure and data sales back to the company is that people see what others are making and their competitive rivalry creates upwards pressure on all pay. The pay consultants’ business model is predicated on comparables and this exacerbates upwards pressure because data is now provided to justify approval by boards. Thus, the law of unintended consequences is perpetuated by the very people benefitting from it: executives and pay consultants.

Boards seem powerless because the entire industry is predicated on a flawed method of paying CEOs. Downward discretion is met by threats to leave, which is also a myth. Having independent compensation committee members and independent compensation consultants, which was also recently mandated, doesn’t change the way CEOs are actually paid.

Therefore, what should a compensation committee do to prepare for the onslaught of pay ratios to come? Three things.

First, don’t let the ratio, the CEO, or the workers drive pay in either direction. Focus on governance and the actual performance within the company, not beyond it. An anomalous ratio could indicate CEO entrenchment or lack of succession, or worker retention, morale, or productivity issues.

Second, resist being overwhelmed by pay data and complexity. You are elected by shareholders to exercise your business judgment and discretion. I have interviewed numerous compensation committee members who are overwhelmed and intimidated by the glossy reports, the expertise of advisors, and the sheer complexity of how pay has morphed. Have a sense of self and the heft and confidence – and competence – to simplify, understand, and push back when you need to. You are driving the bus. Be fearless and do the right thing, as one director recently said.

Third, appreciate the vested interests of pay advisors. You are not obligated to have them. If you ask a barber if you need a haircut, you know what the answer will be. Consultants, when or if needed, work for you, the compensation committee, or at least should do so. Be very willing to oversee metrics and data that are customized to suit your organization and no one else’s.

Proposals to Strengthen a Board’s Role in Value Creation, Management Accountability to the Board, and Board Accountability to Shareholders

There have been a handful of activist threats to Canadian companies recently.

What these engagements have drawn focus on are defects in public company governance, including the skill sets of existing directors, the board’s focus on value creation vs compliance, and the very ways boards function and operate, particularly compared to private equity boards.

What follows is a series of recommendations that could apply to any public board: to make it more focused on value creation; to strengthen real director independence, including from management; to strengthen management accountability to the board; and, perhaps most importantly, to strengthen board accountability to shareholders.

These recommendations are expected to form a journal article I am authoring, and will be incorporated into a case on Canadian Pacific I am co-authoring. I will post the journal article once it is published, but I thought I would post the recommendations below, for commentary and criticism, particularly from my LinkedIn Group “Boards and Advisors.” (I have not included the supporting rationale/commentary for each recommendation, which will appear in the journal article; however, most of the recommendations are rather self-explanatory on their own.)

The recommendations are based on, in no particular order: interviews with activist investors, private equity leaders, directors and CEOs; advisory work with regulators; assessments of leading boards; expert-witness work; academic and practitioner literature and regulations in other countries; director conferences and webinars; lectures I have delivered to the Institute of Corporate Directors and Directors College; discussions in my LinkedIn group, Board and Advisors; and a book I am writing including with Henry D. Wolfe and Frank Feather entitled “Building High Performance Boards.”

Several recommendations may result in significant restructuring and change in how a public company board operates, functions, is composed, engages and focuses.

What follows is a listing of the recommendations, organized into three groupings, as follows:

I.           Increase Board Engagement, Expertise and Incentives to Focus on Value Creation (proposals 1-19)

II.         Increase Director Independence from Management and Management Accountability to the Board (proposals 20-30)

III.       Increase Director Accountability to Shareholders (proposals 31-38)

We will now begin with grouping I.

I.          Increase Board Engagement, Expertise and Incentives to Focus on Value Creation

1.         Reduce the size of the Board.

2.         Increase the frequency of Board meetings.

3.         Limit Director overboardedness.

4.         Limit Chair of the Board overboardedness.

5.         Increase Director work time.

6.         Increase the Board Chair’s role in the value creation process.

7.         Focus the majority of Board time on value creation and company performance.

8.         Increase Director roles and responsibilities relative to value creation.

9.         Increase Director compensation, and match incentive compensation to long-term value creation and individual performance.

10.       Enable Director access to information and reporting Management.

11.       Enable Director and Board access to expertise to inform value creation as needed.

12.       Require active investing in the Company by Directors.

13.       Select Directors who can contribute directly to value creation.

14.       Revise the Board’s committee structure to address value creation.

15.       Hold Management to account.

16.       Disclose individual Director areas of expertise directly related to value creation.

17.       Increase Board engagement focused on value creation.

18.       Establish and fund an independent Office of the Chairman.

19.       Limit Board homogeneity and groupthink.

We will now continue with grouping II.

II.        Increase Director Independence from Management and Management Accountability to the Board

20.       Increase objective Director and advisory independence.

21.       Limit Director interlocks.

22.       Limit over-tenured Directors.

23.       Limit potential Management capture and social relatedness of Directors.

24.       Decrease undue Management influence on Director selection.

25.       Decrease undue Management influence on Board Chair selection.

26.       Increase objective independence of governance assurance providers.

27.       Limit management control of board protocols.

28.       Address fully perceived conflicts of interest.

29.       Establish independent oversight functions reporting directly to Committees of the Board to support compliance oversight.

30.       Match Management compensation with longer-term value creation, corporate performance and risk management.

We will now conclude with grouping III.

Increase Director Accountability to Shareholders

31.       The Board Chair and Committee Chairs shall communicate face-to-face and visit regularly with major Shareholders.

32.       Communicate the value creation plan to Shareholders.

33.       Implement integrated, longer-term reporting focused on sustained value creation that includes non-financial performance and investment.

34.       Implement independent and transparent Director performance reviews with Shareholder input linked to re-nomination.

35.       Each Director, each year, shall receive a majority of Shareholder votes cast to continue serving as a Director.

36.       Make it easier for Shareholders to propose and replace Directors.

37.       Limit any undue Management influence on Board – Shareholder communication.

38.       Limit Shareholder barriers to the governance process that can be reasonably seen to promote Board or Management entrenchment.


There have been significant changes to corporate governance in the last few years. Most notably, boards and regulators are now dealing with a defective legacy of independent directors who do not possess the relevant expertise. The scholarship has never supported independent board or separate chairs and the causal relationship to corporate performance. Regulators and most recently shareholders are now are focusing on competencies.

Second, there has been an under-emphasis on strategy and value creation by many boards, at the expense and crowding out of compliance obligations. Shareholders are now addressing this shortcoming.

Third, there is a movement towards shareholders exerting ownership rights to effect the governance of the company and select and remove directors who can address the earlier two points: competencies and skills, and fulfillment of the strategic and value creation role of the board.

Fourth, there is the real perception that directors are beholden to management.

I have addressed in the above recommendations all four defects in the current governance model for public companies: (i) directors selected primarily with a view to formal independence; (ii) not addressing fully the strategic and value creation role of the board; (iii) shareholders having greater say on directors and value creation; and (iv) making boards more independent of management, and management more accountable to boards.

I am happy to respond to any of the above.

Richard Leblanc, PhD

Does Your Board Chair and Governance and Nominating Committee Need A Reset?

I am currently interviewing shareholder activists, hedge funds and private equity leaders on changes to public company boards to make them more focused on value creation and company performance. I am also interviewing leading directors and CEOs. My research reveals a disconnect between how many boards operate and how shareholder advocates believe they should operate.

For a board to operate effectively, it starts with an independent and effective Board Chair and Governance and Nominating Committee, which are the leadership and inner workings of a Board. It is here where governance accountability is established and good directors are selected, or not.

The focus since Sarbanes Oxley has been on the Audit Committee, and since Dodd-Frank on the Compensation Committee. But without an effective Board Chair and Governance and Nominating Committee, management accountability to the board, and board accountability to shareholders will be undermined.

If you want to make your Board more focused on company performance and value creation, ask yourself whether your Board Chair and Governance and Nominating Committee can answer “yes” to most of these questions, based on my interviews, in no particular order:

  1. Has the Board set standards for a vigorous value creation process, and does its value maximization plan clearly and simply spell out key timelines, milestones, targets, and individuals accountable for each key plan component and specific results? (Is the Board’s plan as good as or better that what an activist shareholder can provide? It should be.)
  2. Does each Director have the background into the company, the business model, the industry and markets to fully understand the value drivers and associated risks? (If not, does the Chair and Board have the backbone to replace those directors?)
  3.  Leadership goes well beyond whether the Chair is independent or not. Does the Board Chair possess the following attributes: Shareholder mindset, leadership, understanding of the value creation process and the capital markets, ability to view things holistically, an ethic of accepting personal responsibility, industry experience, and no desire for CEO role? (If not, is the Governance and Nominating Committee strong enough to recommend to the Board to replace the Chair?)
  4. Do the Board and Board Chair have the will to hold management to account for results and the courage to act decisively when needed?
  5. Does the Board ensure direct links to performance and value creation and the need to hit certain targets before any executive incentive compensation kicks in?
  6. Does each Director have a meaningful portion of his or her own savings invested in the company?
  7. Has the Governance and Nominating Committee recommended to the Board adopting shareholder accountability practices and removing entrenchment devices and other restrictions?
  8. If or when needed, does the Board and each Board Committee utilize resources and advisors independent of management who represent the interests of shareholders?
  9. Does the Board Chair and Governance and Nominating Committee look to shareholders for prospective directors, rather than to management?
  10. Does the Governance and Nominating Committee ensure that all governance terms of reference been redesigned to reflect the Board’s focus on value creation and company performance? (Many times these terms of reference written by management keep the board at bay.)
  11. Does the Board Chair and other Directors engage regularly and directly with key shareholders, without the presence of management? (The vast majority of boards do not meet with shareholders.)
  12. At these Director-Shareholder meetings, are the following matters covered off: Value creation and company performance; status of governance initiatives; board and committee composition and renewal; risk governance; and the governance of executive compensation?

If you answered yes to all questions, or even almost all, you likely have a truly outstanding Board Chair and Governance and Nominating Committee. You may even wish to apply for a governance award, here.

If you cannot answer yes to the majority of these questions, you have work to do.

Join me in my next blog where I will discuss “What makes for a high-performance Director?” based on about 30 interviews with shareholder advocates, search firms and members of the NACD 100 and Top 100 CEO listings.

Does Your Compensation Committee Need A Reset?

Executive pay practices are in the news on a regular basis. Just in the past few weeks, after meeting with investors, the performance metrics for Citigroup were changed following a failed say on pay vote a year ago. Yesterday, it was reported that Apple has required executives to hold triple their salary in stock.

The heat is now on Compensation Committees – who approve and set executive pay – more than ever before. Academic institutions are also keeping up, training our next generation of executives and directors on the rapidly changing terrain of best compensation governance practices and shareholder accountability. See the new course I developed for York University in this area, here.

What are the top pay practices for Compensation Committees? There are fifteen, listed below.

But before you read, ask yourself if you are a Compensation Committee member (or even a Board member not on the Committee), how many questions you can answer “yes” to.

If you are an investor, who will have a say on pay this upcoming proxy season, ask yourself if Compensation Committees at your investee companies conform to the practices below. The more questions that can be answered “yes,” the greater the likelihood there will be pay for performance that is directly aligned with value creation for you as a shareholder.

  1. Does each Compensation Committee member fully understand the company’s business model, the key value drivers, and the performance metrics arising from achieving the company’s strategy?
  2. Does the Compensation Committee precisely calibrate these metrics such that there is a direct line of sight and sufficient stretch for short-term bonuses and long-term performance-based equity?
  3. Has the Committee or an expert third party independent of management benchmarked your Compensation Committee Charter to best practices?
  4. Have you approved, and can you defend, the compensation of oversight functions (e.g., internal audit, risk, compliance) and key risk-takers within the organization? (Assume compliance failure occurs and these pay practices receive expert scrutiny.)
  5. Would a third party, after diligent checks into Compensation Committee member backgrounds and relationships to management, reasonably conclude that all Committee members are fully independent? (There are several red flags that may not be captured by formal independence standards – e.g., interlocks, reciprocity and social relatedness.)
  6. Do you have one female non-CEO on your Compensation Committee? Do you disclose the competencies and skills for each Compensation Committee member on your website?
  7. If you use a Compensation Consultant to assure compensation, has the entire firm or the person never done work for management before, and would otherwise be objectively viewed as fully independent?
  8. If you retain a lawyer to advise, negotiate or draft compensation agreements or pay plans under the Committee’s direction, has that lawyer never done work for the management before, and would otherwise be objectively viewed as fully independent?
  9. Do you have bonus deferral and equity vesting and hold requirements that are performance-based and risk-adjusted by the Committee?
  10. Would your compensation disclosure satisfy an investor as being fully transparent, understandable, clear, and absent of obfuscation or gaming? Do all Committee members fully review the disclosure, or have an independent advisor do so under the Committee’s direction?
  11. Whenever CEO compensation is discussed, the CEO leaves the room.
  12. Does each Committee member issue a cheque from their own savings to satisfy stock ownership requirements? (In other words, the stock is not given in lieu of board service, but they must pay for it.)
  13. Does your Compensation Committee meet directly with key investors to hear their views, without Management in the room?
  14. Does every Compensation Committee member have tenure on the board not exceeding nine years?
  15. Are key contractual provisions, such as a “clawback” or “malus,” and pay practices drafted by the Committee or an advisor independent of management who reports to the Committee, incorporating best practices?

If you answered yes to all questions, or even almost all, you likely have a truly outstanding Compensation Committee and pay for performance. You may even wish to apply for a governance award, here.

If you cannot answer yes to the majority of these questions, you have work to do.

Join me in my next blog where I will ask if your Nominating and Governance Committee needs a reset.

Should governance lawyers be independent?

Most boards need professional advisors, such as auditors, compensation consultants and lawyers. After Enron and WorldCom frauds of 2002, regulators stepped in to ensure that auditors were hired by – and accountable to – the audit committee of the board, on behalf of shareholders, and not hired by or unduly influenced by the CFO as they once were. After the financial crisis of 2008, regulators stepped in (in 2012) to ensure that compensation consultants were hired by the compensation committee of the board and not hired by or unduly influenced by the CEO or other management. What about lawyers? Should lawyers who act for management also advise the board of directors? I don’t think so.

Now there are strict independence requirements for both auditors and compensation consultants. Their primary client is the board of directors and ultimately shareholders, whom the board is there to represent. It is entirely probable that if you do your job properly as an auditor or compensation consultant, that you will make recommendations that management will not like. You are there to act on behalf of the board and shareholders, not management. You cannot have dual masters and fulfill your fiduciary duties to only one as a professional. Indeed, auditors and compensation consultants cannot provide any additional services to management without the express consent from the board or a committee of the board. This authority is – or should be – rarely granted now.

Lawyers are equally important in the field of corporate governance. They interpret and apply legislation and offer advice to a variety of constituencies – shareholders, directors, managers and other stakeholders – who have interdependent and even adverse interests in the well being of the corporation and the competition for scarce resources. If the above reasoning is correct, so far as auditors and compensation consultants is concerned, strict independence should also apply to lawyers.

What this means is that a lawyer (or even a law firm) who has acted, or currently acts, or seeks to act, for management, should be prohibited from also acting for the board. This independence requirement is not practiced currently. There are numerous lawyers and law firms who act for both management and boards. Because most fees originate from management work, the consequences of this is a pro-management bias exhibited by lawyers who have drafted protection and entrenchment mechanisms for management such as poison pills, dual class shares, restrictions on meetings and voting, and staggered boards. Lawyers then resist pro-shareholder governance reform such as majority voting, say on pay and proxy access.

When interests between management and shareholders become adverse, even through the regular course of events, it is important for boards to have their own set of lawyers who are independent from management and seen as objective and willing to act in the interests of directors, not management, and ultimately shareholders. Management lawyers frequently exhibit an anti-shareholder bias, using words such as “attack,” “dissident,” and “proxy fight.” See here for example: Dealing With Activist Hedge Funds. Shareholders suffer when the board retains advisors who are beholden to management.

Some services this new set of “governance-only lawyers” could offer include:

  • Drafting board guidelines, committee charters and position descriptions for the board [if drafted by management lawyers, as they are now, these policies are often pro forma, management friendly, and restrict the board unnecessarily];
  • Board and committee reviews of effectiveness [typically these reviews are done by management or management lawyers currently];
  • Advising the board on activist shareholders, institutional shareholders and overall shareholder engagement [these governance lawyers would have a shareholder not a management mindset];
  • Reviewing and opining on the annual proxy circular, on behalf of the board [typically the board does not have the time to do a detailed review];
  • Review of the strategic planning process and value creation by management, on behalf of the board [again, with a shareholder mindset];
  • Negotiating and drafting the CEO contract and its terms, on behalf of the board and shareholders [typically a management lawyer drafts the agreement];
  • Assessments of risk management and oversight functions, on behalf of the board [again, the assessment would be independent of management and lawyers would work with independent auditors as necessary];
  • Ongoing coaching and development and review of implementation of policies, on behalf of the board.

All of the above activities and services are currently offered by management lawyers primarily from the point of view of management, not the board and not shareholders. This needs to change. The lawyers involved should fall into line (or camps), just like the auditors and compensation consultants have. There is room for governance lawyers who are unambiguously there to act only for directors, on behalf of shareholders.

Are Law Firms Conflicted in this New Governance Normal?

Should a board use the same law firm that management uses? I don’t think so. They teach you in law school that you cannot act for two clients whose interests are, or could be, adverse, e.g., a husband and wife in a divorce, a purchaser and vendor of a home, and so on. You can only act for one client at a time. Governance is really no different. The job of the board is to control management in the interests of shareholders. So how can a board use the same law firm that management uses? The interests of the board are inherently adverse to management.

When a board negotiates compensation for the CEO, it should have independent compensation consultants and lawyers. I sat beside a CEO at a conference once and he remarked to me “I will outgun any compensation committee.” When I asked why, he replied that they do not have the expertise or resources. Well, maybe they should.

Another real example: If a lawyer has drafted anti-takeover devices to entrench management, such as poison pill, should that same lawyer act on behalf of a special committee of the board? This is an inherent pro-management bias, is it not? What about an investment bank that has also done work for management? This is a conflict too.

The issue is that it is far more lucrative for professionals to do work for management, rather than the board. In Sarbanes-Oxley, we now have auditors who cannot do non-audit related services for management, absent explicit approval. The Securities and Exchange Commission, in implementing Dodd-Frank, announced a few months ago that compensation consultants working for the board must now be independent from management. Proxy advisors may be regulated prohibiting their offering consulting services to management. The same rule should apply to lawyers.

The board must be free to retain its own advisors so they are not “out-gunned.” Shareholders will lose when this happens.

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