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Ohio State University N.Y.

Times Deal Professor

-Steven M. Davidoff

The Future Direction of Corporate Governance

Three-dimensional corporate governance The unintended consequences of corporate governance A move to substance from the current procedural focus for corporate governance What is ISSs role in the future debate?
Is corporate governance moving up, down or sideways?

Corporate governance is dynamic and evolving at a high rate Corporations are responding multidimensionally to counter the current corporate governance movement

Corporate governance currently focuses on private ordering, Delaware and federal regulation (including NYSE and Nasdaq rules) But corporations are shifting the fight to new terrain . . . .

Example 1: The State Override Iowa, Oklahoma, and Indiana have all recently adopted mandatory staggered board provisions
Generally stricter than the Massachusetts provision

Oklahoma legally mandates staggered boards until January 1, 2015. Adopted at the request of Chesapeake Energy.

Example 2: IPO Lock-in Provisions Companies are adopting locked-in staggered board provisions, dual class shares and other shareholder unfriendly governance provisions at the IPO stage
Linked-In has a dual-class structure with a staggered board provision that can only be repealed by a vote of 80% of shareholders. Zynga is proposing a tri-class structure providing its founder 70 votes per share (public shareholders receive one vote)

Example 3: The Rise of Forum Selection Provisions for Delaware litigation

Companies are adopting forum selection provisions which provide that all shareholder litigation will occur in Delaware What effect will this have on Delaware courts and law?
82 exclusive charter and by-law provisions adopted to date1

Source: Claudia H. Allen, Delaware CorporationsCan Delaware Forum Selection Clauses in Charters or Bylaws Keep Litigation in the Court of Chancery? (April 18, 2011)

Example 1: Say on Pay Soviet-style approval rates (but no different than director elections) Some numbers for 2011 proxy season:

8 companies fail in the S&P 500 (2 percent failure rate) 30 of the Russell 3000 failed (1 percent failure rate) ISS recommends against 340 out of 3,009 (11.53% rejection rate)
Over-whelming majority of ISS no recommendations are rejected

Moving corporate governance sideways: Is this merely justifying ever-increasing executive compensation?

1. As of September 27, 2011. Source: sayonpay.com

Example 2: SEC Loses Proxy Access Battle in D.C. Circuit


Lets all recognize that proxy access is dead The battle now shifts to 14a-8 proposals Companies know that any controversial rule is subject to relitigation and possible veto by the SECs ber-regulator, the D.C. Circuit What role does a 3-2 adoption play? Cost-benefit analysis?
The D.C. Circuit has struck down mutual fund rules on chairman independence (twice), hedge fund registration, and investment adviser rules among others.

Example 3: Applying Corporate Governance Rules doesnt always end well

ISS recommends withhold vote at IAC/Interactive Corp. because they do not have a nominating committee Result: Nominating committee formed elects Chelsea Clinton

What are the goals of corporate governance? Or is it really about executive compensation and corporate governance is a means to that end?
Is this all about maximizing shareholder wealth What do the academic studies say?

Corporate governance rules focus on procedure They (largely) do not dictate substance Du jour philosophy in Delaware with a particular focus on director independence

Example 1: Independent directors do not equal good directors


Citi, Enron, and Lehman boards all rated highly for independence and director expertise

Example 2: ISS recommends compensation based on structure The number doesnt matter. . . . Cant be right. Right?
Larry Ellison 2010 compensation: $84.5 million. ISS rating for compensation: low concern Measuring substantive compensation against median compensation is a fools game dooming you to ever higher pay . . . .

Example 3: ISS merger recommendations ISS is not a hedge fund investing based on voting outcomes

The problem of unknowable long term vs. known short term expectations

But is this how the market views it?

Long term shareholders often sell-out upon a merger event to short-term hedge funds who will say no (e.g., Dynegy)

The next big battle in corporate governance is going to be over board accountability . . . When should directors be held liable?

When should directors be replaced?

Currently, directors are more likely to be hit by lightening than be held personally liable

We are seeing these questions unfold at HP, News Corp. and Yahoo

Are boards capable of exercising the power we are giving them

Boards seem to be constitutionally incapable of exercising real oversight responsibilities Wachtell proposes to pay directors more for their increased responsibility

The sad examples of Cedar Fair, Dynegy, HP, News Corp, Yahoo . . .

What is ISSs role in all of this? Some thoughts for today:

Should ISS focus more on substance in terms of board qualifications and conduct as well as executive compensation What empirical evidence is required to justify ISS corporate governance recommendations? If not ISS then who?

We are entering into a much more complex battle over corporate governance I believe the debate is going to shift into a conversation about substance over procedure The competency of boards should be a key topic Board accountability is another ripe subject

There is no good long-term measurement of whether governance - measured by substance and outcomes for shareholders is improving, getting worse, or going sideways

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