The Hoover Institute is funded by the usual suspects in the ultra-right, climate change denial, corporate power community: ExxonMobil, Kochs, Scaifes, Donors Trust, etc. Corporate apologist David F. Larker, who does not disclose the funders of his research at the CEO-supporting Rock Center at Stanford Law School, and his colleague Brian Tayan have a new paper published by the Hoover Institute that purports to be about how little we know about what constitutes good corporate governance. It refers to this as “seven gaping holes.” It does not point out that we have had to learn what bad corporate governance is through unfortunate experience: the financial meltdown, the Enron-era accounting frauds, etc. You’d think they might understand the idea that doing the same thing and expecting a different result is the definition of insanity or at least, given their areas of study, the concept of risk-benefit analysis.
This entire paper is just like the talking Barbie that got into trouble for saying, “math is hard.” Larker and Tayan shrug their shoulders and say that it is just too difficult to figure out what makes an effective board, what constitutes independence, what makes effective CEO pay, what constitutes pay for performance, and the role of shareholders and stakeholders.
We note first that items 1 and 2 are the same thing, and items 3 and 4 are the same thing, so whether the holes are gaping or not, there are only five of them.
With regard to board effectiveness, as we have said for more than 20 years, and as the basis of a successful company we created and sold (now called GMI Ratings and part of MSCI), there are no structural solutions that cannot be undermined and it is not useful to rely on anything that fits on a checklist to evaluate the effectiveness or independence of a board. There is only one way to evaluate the effectiveness and independence of the board and that is to look at their decisions, particularly the decisions where there is the greatest potential for conflict of interest between investors and executives. Three top examples: pay (executives want less variability; investors want more), financial disclosures (executives want less transparency; investors want more), and acquisitions (executives would rather buy new shiny toys than improve operations; investors know that as many as 70 percent of acquisitions fail to add value).
Excessive CEO pay is not just a failure to tie pay to performance; it is the clearest indicator that the board does not have the ability (expertise and independence) to say no to the CEO. The same goes for financial disclosures and acquisitions. We don’t rate a movie by who is in it; we rate it by how good the end result is. We don’t rate the effectiveness of a pipe discharging effluent into the river by its engineering specs; we rate it by what comes out of it. The only way to rate a board’s effectiveness and independence is by the decisions it makes.
“A sixth hole in our knowledge of governance is whether certain shareholders are “better” for a corporation than others,” they write. Not exactly. As our chair, Robert A.G. Monks wrote in his 2013 book, Citizens DisUnited: Passive Investors, Drone CEOs, and the Corporate Capture of the American Dream, a corporation where no shareholder owns more than an index percentage will underperform. In other words, whether it is cause, effect, or both, if no one believes in the future of the company enough to buy more stock than its percentage of an index, there is no shareholder oversight, no accountability, and the company is a short sell.
A robust system of capital allocation requires a variety of investors. Some may be day traders looking for quick gains. Some may be permanent holders like index funds. All investors should be treated with respect, but executives and boards should never sacrifice long-term goals for short-term gains.
That brings us to the last “gap:” stakeholders. A reminder that it is not the investor community who is asking for trade-offs of financial and social goals. It is the Business Roundtable, a group of top CEOs. No company can stay in business if it neglects the interests of its employees, customers, suppliers, and community. The only way to meet the obligations to stakeholders and shareholders is for corporate boards and executives to focus on long term, sustainable growth. That means fearless, daily assessments of critical indicators like division by division cost of capital and ROI. If we can’t keep in mind the essential foundation of how markets depend on trust, based on transparency and accountability to minimize agency costs, we might as well shrug our shoulders and say, “capitalism is too hard.”