Corporate governance is a myth

Corporate governance implies laws, methods, and metrics for governing our public corporations. As such, it's a myth. Here's why.

The concept of corporate governance implies consistent and effective laws, methods, and metrics for governing our nation's public companies. The sad fact is that there is no such thing. It's a myth. Here's why:

People talk about the fiduciary responsibility of boards of directors. What that means, in plain speak, is that boards are supposed to:

1) Hire and fire the CEO and appoint other corporate officers
2) Compensate the CEO and other corporate officers
3) Oversee corporate strategy
4) Represent shareholders in the transparent and effective governance of the company

As an ex-officer of several public companies and as a consultant, I've been involved with lots of boards, executive staffs, investment banks, VCs, corporate attorneys, and the like. At least in my experience, boards don't operate the way they're supposed to.

Let's take the last point first. Shareholders are offered a slate of directors and a handful of issues to rubberstamp. That means they have two choices: accept or reject.

Now, let me ask you this. If your spouse or doctor says, "Here's my recommendation, take it or leave it," what do you do? That's right, you take it. Is it the best thing for you? Who the heck knows? You had a gun to your head so you nodded up and down.

Also, who do you think comes up with those director candidates and other issues to vote on? That's right, the CEO and certain other corporate officers. Some companies employ executive search firms for new directors, but the CEO and certain other corporate officers still oversee the selection process.

Moreover, if you're like most investors, you gave up your voting proxy long ago by investing primarily in various funds: mutual, hedge, exchange-traded (ETF), whatever. You're represented by so-called institutional investors. And their strategy is simply to diversify. They spread their investments around to minimize the effect of any one company. If they don't like what's going on there, they take their money out and put it somewhere else. Case closed.

So the whole voting thing is largely perfunctory.

Then there's the oversight function. Boards typically only see presentations that are scrutinized, sanitized, and polished by the executive management team. During board meetings and in individual meetings, directors offer perspective and advice, but the management team is not obligated to follow that advice or even to close the loop. There literally is no accountability other than, you guessed it, compensation and termination.

All the executive compensation plans I've seen were actually developed internally, albeit sometimes using external or objective data. Then they're ratified by the board's compensation committee, but that's just the rubberstamp thing again.

Also, boards consist mostly of current or retired executives chosen by the CEO, as well as VCs and other investors who've been on-board forever. Whom do you think they sympathize with?

Sure, if executive staffs and CEOs fail to meet their objectives, they may not get paid as much, but as I said, that's essentially a self-governing function.

As for hiring and firing CEOs and appointing other corporate officers, let's start with the last part first. Sometimes directors interview executive officer candidates, but the CEO has the final say on who to hire. Again, the board just rubberstamps the appointment.

As for the CEO, many companies have only had one. That aside, yes, boards hire CEOs. But it's not as if shareholders have anything to do with that, since they just rubberstamp the directors and the CEO, as we discussed above.

And, for all the reasons already stated and a host of others--some of which are actually in the best interests of shareholders, like disruption to the company and its business, that sort of thing--boards are reluctant to terminate CEOs. In the rare event that they do, it's no skin off their back if the CEO has a sweet termination package , especially since that's the norm in corporate America.

So there you have it, all the reasons why most public companies are, in practical terms, primarily self-governed.

How about the Sarbanes-Oxley Act of 2002, aka SOX? Let me tell you about SOX. Enron, WorldCom, and Tyco happened. Your elected officials saw an opportunity to get brownie points, so they got involved and came up with this gem of legislation. Sure, there are one or two good things about it, but on the whole, SOX goes way overboard.

First, SOX compliance comes out of shareholder's pockets. Second, SOX taxes our nation's ability to compete in the global marketplace. Third, there's no clear evidence that SOX would have prevented Enron et al. It certainly didn't prevent 1,300 corporate fraud convictions since 2002.

As for so-called activist investors like Carl Icahn, certain hedge funds, and the like, they're just big, short-term investors who are in it for themselves. Whether their efforts help long-term investors, institutional investors, or the company itself, is ancillary, as far as they're concerned. In some cases they help, in others they hurt, and in all cases they and their proxy battles are huge distractions for the management team and disruptive to the company.

What does all this mean? It means that our system of corporate governance, if there even is such a thing, is dysfunctional at best. What can you do about it? Diversify. It's that simple. I know, diversifying is a big pain in the butt and you don't do it as much as you should . That's fine. But when the next bubble bursts or the stock you've bet your retirement on collapses because somebody committed fraud, don't blame it on corporate governance. Just pick yourself up from the rubble, dust yourself off, and put everything you have left in ETFs. You'll sleep better at night.

 

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