Corporate Governance: Important Trends

1
Corporate Governance Important Trends

• John M. Holcomb
• Institute for Enterprise Ethics
• May 14, 2015

2
Topics

• Ethics and Compliance
• Corporate Political Activities
• Shareholder Activism
• Executive Succession
• Cybersecurity

3
Reputational Risk Management

• Failures in crisis management
• BP Wrong leader in Hayward Lax assessment of
  risk Failure to implement message on safety
  Cozy relationship with regulator Abuses in
  victim compensation plan
• News Corp Failure of internal controls on
  hacking and privacy invasion Cozy relationship
  with police and governmental elites
• GM No upward communication of bad news
  tradition of blaming others Group think board
  in denial

4
Lufthansa and Germanwings Crash

• Suicidal co-pilot and tragic passenger deaths
• Company was aware of co-pilots history of
  depression and his previous treatment and leave
  of absence
• Lack of scrutiny in allowing him to return
• Current strategy of reliance on low-cost carriers
• Supervisory board of 20 members
• 10 are employee representatives
• 5 are women
• Robert Kimmitt is American representative

5
Ethics and Supply-Chain Management

• Major problem for several companies
• Nike in southeast Asia, and Wal-Mart
• Apple and Foxconn
• Several companies and factory burnings in
  Bangladesh
• Levi Strauss and control of labor practices by
  contractors in China and southeast Asia.
• Rainforest Action Network partnership with Home
  Depot on old growth forests

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Importance of Roles of Board Compliance and
Corporate Responsibility Committees

• Taking Caremark duty seriously to monitor
  internal controls
• Mitigating factor under Sentencing Commission
  guidelines
• Avoiding a charge under the McNulty Memo
• Complying with conditions of deferred prosecution
  agreements or legal settlements
• Adapting to onerous burden placed on audit
  committees
• Realizing the limits of the 3 major committees
  audit, compensation, nominating committees
• Prevention of future fraud and legal violations

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Why and How to Examine Roles of Board
Compliance/Public Responsibility Committees

• Penetrating any smokescreen or sham
• Going beyond the labels
• Content analysis of committee charters
• Length of committee charters
• Frequency of committee meetings
• Examining the numbers of women on board
  committees
• Separating the crucial from the important

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Fortune 200 Non-Audit Committees with Compliance
Roles

• Company Committee
•  Abbott Labs Public Policy
• Johnson Johnson Regulatory, Compliance,
  and Government Affairs
• Pfizer (Ironic) Regulatory and Compliance
• Amgen Corporate Responsibility and
  Compliance
• AIG Regulatory, Compliance, and Public
  Policy

9
Non-Traditional Board Committees

• 101 of the Fortune top 200 companies have board
  committees on Public responsibility,
  Sustainability, Risk management, EHS, or
  Regulatory compliance and risk
• Public responsibility committees have an external
  focus while ethics and compliance committees have
  an internal focus.
• The former are important, while the latter are
  crucial
• Best Practices Wells Fargo has three such
  committees

10
Whistleblower Protection

• SEC reports that all but one whistleblower filing
  a complaint under Dodd-Frank law had complained
  internally first and exhausted internal channels.
• Payouts of 50 million so far to 15
  whistleblowers
• Retaliation and pretaliation (action to prevent
  whistleblower)
• KBR case SEC cracking down on confidentiality
  agreements
• Exceptions allowing corporate attorneys to blow
  the whistle
• Significant harm to investor
• Company has actively impeded the investigation
• Internally reported and no action taken within
  120 days
• N.B. May also be ethically obligated to then
  blow the whistle

11
New Rules

• Disclosure of investments in conflict minerals
  Amnesty International and Global Witness Report
  that 80 percent of companies are not in
  compliance high expense for limited benefit
• Rule on disclosure of pay and performance
• Comparison to peers
• Total shareholder returns, including dividends,
  over 5-year period
• Compensation actually paid in a given year
• Pay gap rule yet to come

12
Impact of Citizens United decision on Corporate
Political Involvement

• Business PACs Shun Endorsement Campaigns
• Reputational Damage
• Shareholder Opposition
• Business Shuns Independent Committees
• Morgan Stanley has refused to engage in
  independent spending and relies on PAC
• GM used bailout money to fund candidates
• Continued Reliance on PACs
• Nonprofit Groups, Super PACs, and Wealthy Donors
  Benefit over the Political Parties

13
Roles of the Center for Political Accountability

• Created a model shareholder resolution
• Created corporate rankings and scorecard
• Basic emphasis is on disclosure discussion of
  disclosure on later slide

14
Highest Ranking Companies

• By all measures, IBM is the gold standard. It has
  a long-standing policy prohibiting the use of
  corporate money for political spending. The
  company also has no PAC and received a perfect
  score in a comprehensive report by the CPA
  published late last year.
• Still, its investors then wanted to know how much
  in dues the company pays to trade associations
  and other organizations that can hide any
  contributions. And they want a comprehensive
  report on lobbying activities.

15
Highest Ranking Companies in Political Disclosure

• In the CPAs latest 2014 survey report, CSX and
  Noble Energy rank the highest on political
  accountability and disclosure of political
  activities.
• Rounding out the top ten are Becton Dickinson,
  Capital One, Exelon, Qualcomm, UPS, AFLAC, and
  Biogen

16
Model Resolution of the Center for Political
Accountability

• Report soft money contributions, independent
  expenditures, and payments to trade associations
  and other tax exempt organizations that are used
  for political purposes
• Identify the titles of the individuals involved
  in the expenditure decisions
• Disclose their political spending guidelines and
• Require the board of directors to conduct
  oversight of the company's political spending.

17
Critique of CPA Criteria

• Ignore key elements of corruption
• Inclusion of items unimportant to investors
• Using PAC as exclusive avenue is not even scored
• Danger in check-the-box test
• CPA enjoys a monopoly on setting the standard
  comparison to governance ratings

18
Key Elements of Corruption Ignored

• Direct lobbying ten times the amount
  contributed to candidates
• Contributing to political party conventions
• Contributing to 501c-3 nonprofits and foundations
  tied to candidates
• Giving specifically to judicial elections and to
  candidates for state attorney general
• Bundling

19
New Scoring and Ranking Results

• Questions added and method top 2 tiers
• Every companys score is lowered
• Some in upper tier move to lower tier, and vice
  versa
• Lots of changes in rank orders
• Some make dramatic moves upward

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Questions Added to List of Criteria

• Does the company have a policy restricting
  bundling of political contributions by
  executives? Or
• Does the company disclose the money raised
  through bundling and then contributed to
  political candidates? 6 Points
• Does the company restrict and/or disclose
  contributions to political party conventions? 2
  points
• Does the company restrict contributions to public
  policy think tanks or foundations that have been
  established by or affiliated with political
  candidates? 2 points
• Does the company disclose the amount it spends on
  direct lobbying of Congress or other branches of
  the federal government? 2 points
• Does the company disclose the amount of money it
  spends on direct lobbying of state legislatures
  and/or foreign governments? 2 points

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Questions Added to List of Criteria

• Does the company disclose the amount of money it
  pays to law firms or political consultants to
  represent its political interests in the national
  or state capitols? 2 points
• Does the company prohibit contributions to super
  PACs or c-4s? 4 points
• Does the company disclose amounts spent on super
  PACs or c-4 Committees? 4 points
• As to question 11 in the CPA list, it should not
  simply be a yes/no question but should be
  allocated 6 points, with full credit given to
  those companies that restrict political
  contributions through the PAC, the legally
  authorized component. Companies that also ban
  PAC contributions should not be given more credit
  for political responsibility, but should be
  penalized.

22
Lower Scores with New Criteria Old Scores
New Scores

• 90-100 A 20
• 80-89 B 32
• 70-79 C 35
• 60-69 D 17
• 0-59 F 0

• 90-100 A 0
• 80-89 B 0
• 70-79 C 20
• 60-69 D 51
• 50-59 F 33

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Tier 2 to 1 Tier 1 to 2

• Anadarko Petroleum
• Applied Materials
• Reynolds American
• Boston Scientific
• Eli Lilly
• Lockheed Martin

• Air Products Chemicals
• Costco
• Illinois Tool Works
• Dow Chemical
• eBay
• CVS Caremark

24
Dramatic Move Upward for Some

• Pfizer
• In rank 11 by CPA score
• In rank 6 by new score
• Applied Materials
• In rank 17 by CPA score
• In rank 12 by new score

25
Shareholder Activism and Proxy Fights

• Tempur Sealy case CEO, Chairman, and head of
  governance committee all resign under investor
  pressure from H Partners hedge fund (10 owner)
  Four proxy advisory firms supported negative
  votes
• DuPont/Trian case white hat activist wanted
  seat on the board for Peltz ISS backed all four
  Trian candidates while Glass Lewis only supported
  Peltz DuPont not a broken company Lipton
  acknowledged Peltz would bring value to the board

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Reactions to Activist Shareholders

• Success rate of activists is declining
• More push-back from company boards
• Targets are now smaller companies of less than
  10 billion in assets
• Former activists will now settle more easily and
  are focusing on other issues
• New players are emerging

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Reactions by Opponents

• Fink of BlackRock
• Advises firms not to pander to investors and
  decries short-termism
• Opposes higher dividends and buybacks
• Advocates shifting tax policy to favor long-term
  holdings
• Marty Lipton Activism has caused companies to
  cut R. D., capital investment and, most
  significantly, employment. It forces companies
  to lay off employees to meet quarterly earnings.
  It is a disaster for the country.

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Reputational Risk Management Failures in
Leadership and Succession Planning

• Hewlett-Packard multiple chapters from Fiorina
  to Hurd to Apotheker to Whitman
• Invading privacy of board members and reporters (
  by board chair Patricia Dunn)
• Questionable personal relationship and expense
  account fraud (Hurd)
• Strategic missteps (Apotheker)
• Board in disarray (due to privacy scandal and
  disagreements over leadership and strategy)

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Failures in Leadership and Succession Planning
cont.

• Pfizer from McKinnell to Kindler
• Preoccupation with Washington and status
  (McKinnell)
• CEO Compensation scandal (McKinnell)
• Autocratic micro-management (Kindler)
• Reliance on the misjudgments of an HR officer
  (Kindler)

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Cyber security and Cyber attack Risks

• Target case
• Has not yet recovered
• Board was targeted by investors
• Concern over supply chain
• Prevention versus detection
• Private sector and public sector responsibilities
• Board skill set
• Difficult to find board candidates
• Tech expertise does not necessarily coincide with
  business expertise
• Committee domain risk, audit, regulatory
  compliance