Changing of the Guard

If there has been any positive effect to the recent debacles in the world of corporate governance (Tyco, Enron, Adelphia, Worldcom) it is that Wall Streeter’s and Shareholders have become “educated buyer”. The lack of trust has prompted the investment community to take a much closer look at how companies really function. The information below discusses what some “best practice” companies are incorporating into their governance policies to gain back investor confidence.

Quality Board Members

Over the past decade there has been a trend to limit the number of executive officers or (insiders) that sit on a board. Greater board participation should come from impartial outside directors in order to ward off inherent conflicts of interest. While it is evident that “best practice” companies are adhering to this strategy governance experts are recommending that organizations need to look beyond the “usual suspects” for outside director candidates. This initiative will include identifying prospects that have a true understanding of the business they are representing. For example, why should a CEO of a textile company sit on the Board of a Restaurant or Hotel company? What value are they bringing to the table? Furthermore, it should be determined how many boards a Director can realistically serve on given the heightened responsibilities and time commitment. In addition, Sarbanes/Oxley now requires Audit Committee members to have significant accounting experience as a requirment.

Compensation

More than a decade ago, the Securities and Exchange Commission began requiring companies to report salaries, bonuses, and some other forms of executive pay in easy to read tables. Hoping to give investors a clear view of a growing cost, the commission told public companies that they could no longer describe this pay in undecipherable paragraphs. Since then, however, the ways that executives receive payouts has expanded, again leaving investors, regulators and the rest of the public confused when it comes to compensation (special retirement plans, company-paid insurance, investment accounts with guaranteed interest rates and lifetime perks). For example, no one knew the extent of Jack Welch’s retirement package at GE until he went through a nasty divorce. Governance experts believe that “all” executive compensation should be written in an easy to read manner and compiled in one area of the proxy. Furthermore, Director information should be outlined in the same way. The length of the term, cash and stock retainers, meeting fees, annual stock awards and how they are paid (stock grants, stock options, restricted stock), and any other benefits should be formatted in the proxy in an easy to read manner.

Committees Structure and Effectiveness

While committees such as Audit have become mandatory in the Unites States for publicly held companies, and other committees such as compensation and nominating have become part of all modern boards, best practice companies are forming other committees to avoid any oversights and corporate scandals. For example, we have seen several public companies incorporate a corporate governance/responsibility committee that evaluates crucial topics such as interlocks, insider participation, and assesses the overall performance of their respective Board of Directors.

Compensation committees are particularly under the microscope. Experts agree that more information from compensation committees is necessary for investors to make wise decisions. For example, if a company indicates that a consultant was used to devise compensation plans the consultant should be named. Investors could then determine if the consultant has a reputation for placating executive officers. Increasing peer group analysis is another way that best practice companies are communicating with investors. For example, by showing how a company performs relative to their competitors, bonuses could be justified if the company outperforms the market.

While the points above speak to only a few of the critical components of an effective board we will continue to keep you abreast of the many changes going on in the world of corporate governance.