Internal Corporate Governance and External Corporate Governance

Corporate Governance (CG) can be viewed as the system by which companies are directed and controlled. Companies can also be held accountable by CG, limiting managerial discretion in order to protect the interests of outsiders in the corporation.

Such 'outsiders' can be shareholders, stakeholders, other interested parties or even society as a whole.
Any CG 'system' consist of a large number of mechanisms. We can broadly categorize CG mechanisms into two groups:

1. INTERNAL CORPORATE GOVERNANCE
Internal corporate governance encompasses the controlling mechanisms between various actors inside the firm: the company’s management, its board and the shareholders.
In this form, the shareholders and other constituents 'delegate' the controlling function to internal entities or mechanisms, such as the Supervisory Board (in case of two-tier board) or the Board of Directors (one-tier) and/or special committees

2. EXTERNAL CORPORATE GOVERNANCE
External governance encompasses the influences from outside the firm on the governance of the firm. These can originate from a number of external sources.

For more information and examples, see the interesting discussion at 12manage on internal and external corporate governance.

Boardroom Focus in 2011: Growth and Strategy

According to Sarah Johnson of cfo.com, the Boardroom Focus in 2011 will be: Growth. In general, directors will focus more on corporate strategy this year and less on the compliance issues that commanded their attention during the past decade, say experts. More than two-thirds of directors now view strategic planning and oversight as their number-one priority, according to the National Association of Corporate Directors's (NACD) most recent governance survey. Just three years ago, only 24% of directors put strategy at the top of their priority list. Go here for the full article.

Co-Filers Wanted on Petition to Eliminate Street Name Registration

As I indicated in my last post (Can We Change Voting Behavior?), I’m working with the United States Proxy Exchange (USPX) on a petition to the SEC to end “street name registration.” That largely ad hoc system took root under emergency conditions stemming from a paperwork crisis during the 1960s, before networked computers were ubiquitous in trading markets. Street name registration, and a system that immobilized stock, were supposed to be temporary measures but they have grown to undermine our ownership culture. Just as poker chips allow us to play under rules that often favor the house, those holding “security entitlements” do not acquire the rights of real shareowners.

Street name registration is the primary reason proxy solicitations cost hundreds of thousands of dollars—and that exorbitant cost is why entrenched boards routinely run unopposed. Eliminating street name registration, in favor of a direct registration system, could bring the cost of proxy solicitation down to a few thousand dollars, which would have a bigger impact on shareowner rights than the SEC's proposed proxy access initiative. It would also eliminate the use of voter information forms and other vehicles that circumvent the legal rights of shareowners with official proxies.

We welcome interested parties to co-sign the petition with us. The January 12, 2010 draft petition may go though minor revisions, based on your recommendations, but the substantive points will remain. We intend to submit the petition by the end of January to help ensure it is considered by staff preparing recommendations to the Commission concerning how to resolve various "proxy mechanics" issues. If you are interested in signing on to the petition, please e-mail Glyn Holton, Executive Director, United States Proxy Exchange, indicating you want to co-sign, and provide the following:

• Your signature block with your organization affiliation, if any


• Please note the affiliation is for "identification purposes only" if you are not signing on behalf of the organization


• Please include a small pdf of your signature that can be used in the filing

Function, role and qualities of Compliance Officer

Where the accountants have failed, a new supervisor is rising: the (Chief) Compliance Officer.

In an article in the Financieele Dagblad (a Dutch newspaper), Edwin Weller, CCO of Robeco (a Dutch Financial Institution) discusses the function, role and qualities a Compliance Officer should have.

He says that the compliance function is an independant function in an advisory role, aimed at controling the risks that are relevant for maintaining or strenghtening the corporate reputation. However, the final responsibility for controling these compliance risks and for the definition of integrity remains a task of the Executive Board.
Mr Weller says the main personal qualities of a Compliance Officer are discreetness, objectivity, independence, professionalism, and that he should be experienced in relation to the activities of the corporation.
The Compliance Officer should have knowledge about legal, economic, social, operational and commercial aspects and preferably have a legal background.

Do you agree that the role of the Chief Compliance Officer is merely an advisory one? Is protecting the corporate reputation his most important goal? Are the mentioned qualities and expertise areas complete?

Downsizing the CEO

According to Business Week,"directors, auditors, and lawyers are more powerful than ever. That shift has fundamentally altered relations between CEOs and the advisers they depend on. At their best, these supposed guardians of shareholder value, chosen for their ability to complement the CEO and provide specific areas of expertise, were trusted advisers. At their worst, they were little more than bag carriers and sycophants. Either way, these advisers -- who were always supposed to work for the shareholders, not the CEO -- usually exercised their power as watchdogs only in moments of genuine crisis. But now the chumminess and banter have given way to a more adversarial attitude...Even CEOs who don't lose their jobs are finding that their ability to impose their will, whether it's in setting strategy or hiring a successor, has been severely curtailed."

David Henry, Mike France and Louis Lavelle argue "the new rules may initially go too far and create their own distinctive set of problems." Candid conversarions are gone. CEOs are being micromanaged by boards and now seek safe strategies rather than risk confrontations. Pay for performance is the new standard. Board independence makes it harder for CEOs to put together boards that compensate for their weaknesses. CEOs are being bullied by boards, auditors and attorneys. "The downsizing of the CEO has led, to a certain extent, to the supersizing of the advisers. That's not necessarily a cure for everything that ails Corporate America. It is a clue that successful CEOs will have to be consensus builders in the future. And should be a warning to CEOs everywhere: The age of the absolute corporate monarch, such as AIG's Greenberg, is over." (The Boss On The Sidelines, 4/25/05) http://www.businessweek.com/magazine/content/05_17/b3930015_mz001.htm

Really? CEOs still seem to have the power to block the SEC from finalizing its "equal access rule." True, they are less likely to be out and out crooks and that's certainly a step in the right direction. Is the imperial CEO dead?

Sallie Mae Receives Perfect '10' Score for Corporate Governance

SLM Corporation, commonly known as Sallie Mae and the nation's leading provider of education funding, today announced that it has received a "perfect" score of 10 for corporate governance according to the latest ratings issued by GovernanceMetrics International (GMI), the corporate governance research and ratings agency. SLM Corporation was one of only 34 companies globally -- and one of only 27 American companies -- to receive a 10, GMI's highest rating. The average rating for reviewed companies in the United States was 7.03.

GMI's rating system incorporates hundreds of data points across six broad categories of analysis: board accountability, financial disclosure and internal controls, executive compensation, shareholder rights, ownership base and takeover provisions, and corporate behavior and social responsibility. More on Sallie Mae see their website.

Bestselling Corporate Governance Books

Checkbox approach to CG doesn't work

Wharton accounting professors David Larcker, Irem Tuna and Scott Richardson say the check-box approach to CG doesn't work, because companies and their situations are too diverse. "The recipe book is big, and there's a different recipe for each company," Richardson notes. Even worse, the professors say, are consultants and ratings services that use formulas - which they typically refuse to reveal - to boil down a company's CG to a single number or grade.

Yep.

"Lots of people are coming up with G. scorecards," Larcker explains. "They're coming up with best practices and selling this stuff. As far as we can tell, there's no evidence that those scorecards map into better C. performance or better behavior by managers."

Larcker, Tuna and Richardson tried to create a magic formula of their own. But no matter how they sliced and diced G. data (consisting of more than 30 individual measures) on more than 2,100 public companies, they couldn't find one. The three professors have released their findings in a working paper titled, "Does CG Really Matter?" The title is intentionally provocative. They do think CG matters, but after puzzling over reams of company numbers, they are not confident that anyone can measure whether one firm's G. is better than another's at least, not by using typical metrics.

As they say in their paper, "Our overall conclusion is that the typical structural indicators of CG used in academic research and institutional rating services have a very limited ability to explain managerial decisions and firm valuation."

CG pays

A new study released today by GovernanceMetrics International shows corporations that are rated highest for governance practices have delivered superior investment returns.

GovernanceMetrics International said its latest data on 2,588 global companies found that 26 companies receiving the highest score of 10.0 outperformed the Standard & Poor's 500 stock index total return by 10 percent over the last five years.

Over a three-year period the companies outperformed by 8.3 percent and over one year they outperformed by 4.9 percent. The 26 companies included 20 American companies, five Canadian and one Australian.

GMI said the companies also outperformed when measured against the Morgan Stanley Capital International World Index.

"This suggests a correlation between CG practices and portfolio returns when measured across a number of variables and across a multi-year period," GMI Chief Executive Gavin Anderson said in a statement.

Anderson said that U.S. companies as a group had improved ratings over the past two years, with the average rating rising to 7.2 from 6.5. He attributed the better showing in part to the Sarbanes-Oxley Act, a U.S. law that required a series of accounting and CG reforms.

The report said that 95 percent of U.S. companies now say they have a qualified financial expert on their audit committee, compared with 65 percent in an earlier study in 2002.

Nearly three-quarters have hiring policies concerning employees or former employees of auditor firms compared with only 14 percent in 2002.

Just over half of the companies have adopted a policy on rotation of audit personnel compared with 8 percent in 2002.

A big majority of audit committees, 83 percent, now perform self-evaluations compared with 17 percent in the earlier study.

In other changes, 90 percent of companies now have board evaluation policies versus 35 percent in 2002. Director training is provided by 80 percent of companies compared with 14 percent in the earlier study. Only 11 percent of companies say they are paying auditors more for non-audit work as opposed to audit-related work, down from 48 percent in 2002.

The study found that U.S. companies have also improved in independent board leadership, but are behind the UK.

GMI said 95 percent of rated companies in the UK have separated the roles of chairman and chief executive, while only one-third of rated companies in the United States have done so. In the earlier study, 22 percent of U.S. companies had separated the chairman and chief executive roles.

Comparing nations, U.S. companies had the highest overall average rating, 7.23. Canada was second with a 7.19 score, followed by the UK with a 7.12 rating and Australia with 6.73.

Greek companies had the worst overall average rating, 2.93, followed by Japan, with 3.57.

Examples of the 26 companies with the highest rating included Eastman Kodak in the United States, Suncor Energy in Canada and Westpac Banking in Australia.

The GMI rating system uses hundreds of data points that fall into the broad categories of board accountability, financial disclosure and internal controls, executive compensation, shareholder rights, ownership base and takeover provisions, corporate behaviour and social responsibility.

CG analytics, proxy voting and restoring investors trust

Worldwide, institutional investors are gradually becoming more active in monitoring and interfering on C. strategy, policy, and major decisions taken by management.
I would like to point to two important but often overlooked enabling components of this monitoring process and of the CG dialogue. Electronic proxy voting by pension funds, mutual funds and alike, is recently being combined with the use of CG analytics tools and software, providing electronically calculated quotients that indicate the quality of G. in a corporation.
The organizations that use these tools, institutional investors, have a natural long-term perspective towards investing and value creation. 10 years or more is normal.
I believe the combination of these factors will over time play out to have been as relevant to restoring investors trust as Sarbanes-Oxley, accounting restructuring or in fact any other measure being taken, because they increase and restore the influence and power of the shareholders. Institutional investors are ideally suited to increasingly play this important task, because they are professionally educated investors, have a natural long term view towards value creation, and they can also represent and balance out the interests of the stakeholder categories they represent. In the case of pension funds: the employees. After all, it's their pensions that must be ensured.