NYSE Commission on Corporate Governance: Sense in the face of the nonsensical

As the financial markets blew up, and the wealth divide of the US opened up further, cries to change the way companies are run have grown louder and more capricious. Corporate governance has become the fig leaf a board can hide behind. Proxy advisory firms gain more Mob-like power , boards become driven by fear (consider the recent fear-based actions of the HP board) and fewer high quality execs want to serve on public boards (one of the reasons boards get so clubby – hang out with people you know and trust and it feels less risky).

Step in the NYSE to the rescue. A year ago the NYSE sponsored a Commission on Corporate Governance and yesterday they outlined their Key Governance Principles. It’s a pragmatic, sensible document (thank goodness!) that finds the balance between the needs of the shareholders and the needs of boards and management to be able to manage.

Interesting to note – the commission was lead by the indomitable Larry Sonsini of WSGR and of the 27 members the majority are lawyers – typically in the general counsel role. There are no members who you would normally think of as “management” – like CEO, GM etc. but given the topic I guess the lawyers can take the floor.

Here are the 10 core principles – and my interpretation. I sit on two public boards and so welcome some sense being injected into the corporate governance discussion…

The 10 core principles outlined by the NYSE Commission on Governance are as follows:

The Board’s fundamental objective should be to build long-term sustainable growth in shareholder value for the corporation;
Stating the obvious – thankfully – and some people need reminding (HP anyone?)

Successful corporate governance depends upon successful management of the company, as management has the primary responsibility for creating a culture of performance with integrity and ethical behavior;
Yes, management runs the company NOT the board. Something I am acutely aware of as a CEO, and very sensitive to as a board member. Only the CEO knows everything needed to integrate a final decision.

Good corporate governance should be integrated with the company’s business strategy and not viewed as simply a compliance obligation;
Filling out forms and surveys, and reviewing a committee charter once a year is not governance. That’s mailing it in. Governance works when management cares about it as much as the head of the company’s Governance committee – not always the case.

Shareholders have a responsibility and long-term economic interest to vote their shares in a reasoned and responsible manner, and should engage in a dialogue with companies thoughtful manner;
ie. Activist hedge funds interested in only a quick flip don’t help. Likewise don’t follow ISS scores blindly, talk to the company before you vote.

While legislation and agency rule-making are important to establish the basic tenets of corporate governance, corporate governance issues are generally best solved through collaboration and market-based reforms;
The agencies have a black eye after the sub-prime disaster – and more regulation is not likely to help. It’s no substitute for sensible, thinking people at the top on both sides.

A critical component of good governance is transparency, as well governed companies should ensure that they have appropriate disclosure policies and practices and investors should also be held to appropriate levels of transparency, including disclosure of derivative or other security ownership on a timely basis;
Translation – transparency cuts both ways guys

The Commission supports the NYSE’s listing requirements generally providing for a majority of independent directors, but also believes that companies can have additional non-independent directors so that there is an appropriate range and mix of expertise, diversity and knowledge on the board;
Founders and key technologists are absolutely invaluable in strategy discussion. Really, really important (especially in complex companies like one I sit on – Rambus). Blind slavery to all independent directors (except the CEO) is not smart in technology.

The Commission recognizes the influence that proxy advisory firms have on the markets, and believes that it is important that such firms be held to appropriate standards of transparency and accountability;
Did you know that ISS will provide a recommendation on a public company and advise funds whether to vote for managements recommendations – but the company has to buy a piece of software from ISS for $20,000 in order to run the “model” that will tell them how ISS will calculate their score so they can fix it?

The SEC should work with exchanges to ease the burden of proxy voting while encouraging greater participation by individual investors in the proxy voting process;
Make it easier guys and more people will vote. You need the votes of the shareholders to know what they really think – after all in the end they own the company.

The SEC and/or the NYSE should periodically assess the impact of major governance reforms to determine if these reforms are achieving their goals, and in light of the many reforms adopted over the last decade the SEC should consider the expanded use of “pilot” programs, including the use of “sunset provisions” to help identify any implementation problems before a program is fully rolled out.
Sensible. Try before you mandate. These are complex systems and the interaction between the moving parts is not always obvious.

Overall – I love it! Nice job.

Ed: You can see a video of Larry describing the commission’s process and outcomes here.


Why every executive should see the play Enron

If you were watching the news in December 2001, or have seen The Smartest Guys in the Room you know the story. Enron executives Ken Lay, Jeffrey Skilling and Andy Fastow used complexity and creative accounting to build a $60B house of cards which collapsed almost overnight, losing thousands of jobs and billions of dollars of value for its employees and shareholders.

The play “Enron” now running on the London stage is a brilliant, ambitious portrayal of the story over the nine years from 1992 to 2001. Combining traditional high quality acting with a thrilling use of lighting, TV clips, dance and recreations of the frenetic pace of the trading floor, the play brings both the human story, and an explanation of the financial games at work, to life in an explosion of creativity.

Enron is old news now, but watching it the parallels to the financial crisis of 2008 are chilling. The same hubris, the same ambition and greed using the complexity of instruments to hide the reality of what was really going on underneath. It was uncomfortable to watch bankers portrayed as fools, analysts as groupies, the board as the three blind mice and the debt accounts (nicknamed raptors by the CFO) as lifelike raptor masks on the heads of the actors.

I found the play both brilliant and compelling in its reminder of how far very smart people can go wrong in the face of the opportunity to make a great deal of money. How important it is to not lose sight of the basic rights and wrongs of doing business. And how important it is to not believe you are the smartest guy in the room because even if at times you are, the arrogance that comes with that belief can be very destructive.

Sadly Enron failed on Broadway, killed with a witheringly negative review from the New York Times. The review criticized the play as “flashy but labored” and that it “isn’t much more than smoke and mirrors itself” — and it is hard for any New York production to survive a scathing review.

While the Guardian surmised that maybe the play was not conservative enough for Broadway, I think the play may have failed because it’s subject matter would be so hard for many of the New York theatre going public to watch. Too many people would recognize their own lives and careers in it – it’s almost un-American. I saw it in London 2 days ago and was next to a couple from Houston who hated it – they felt insulted by the portrayal of American business. And yet it all happened again less than 10 years later as Lehman Brothers collapsed in 2008.

I believe we need to look boldly into the face of the past disasters of American business – the dark underside of our business culture of chasing the almighty dollar. I was born in the US, grew up in England and choose to work in the US; I admire it and thrive here. But the reminder, through art not just the news, of just how badly it can go wrong is healthy.

Ken Lay and members of the Enron board

Ratcheting up CEO pay – or competing for talent?

If you were on the compensation committee of a public company board how would you set the CEO’s pay?

There is so much written about fat cat CEOs and their unfair pay packages that this is a question worth pondering (if you care). The really hard part about it is judging what is a) fair, b) necessary to get the talent you want and c) the market.

One tool compensation committees use is the “peer group”. This is the list of companies which are “like” your company. They are supposed to be similar in size, similar in market reach, something you can compare with to figure out what your CEO should be paid. But as the Wall St Journal points out recently, the very use of the peer group can cause CEO pay to ratchet up.

The problem goes like this. Most companies are planning to grow and want to have a CEO that can grow the company and make it larger and more competitive. As a result, they pick peer groups that while they have some companies that are smaller, many of the companies on the list are larger with higher paid CEOs than the current CEO – two studies cited by the WSJ confirm this. (The SEC only started requiring companies to publish their peer groups in 2006 so there is now enough data for the pundits and researchers to start to dig.)

At the same time, over 40% of companies cite that they want to pay their CEO’s above market average – numbers like 60% and 75% of market are often used.

So, if your peer group is larger companies where the CEO pay is higher, and you want to pay your CEO above market, you will take CEO pay up. It’s a compounding phenomenon.

Sounds like a conspiracy right? Well, sitting on two very quality compensation committees I can tell you from experience it isn’t. It’s a very real challenge for boards to figure out the right level of pay. High enough to attract a great CEO who can take the company on the growth journey you want (which takes both smarts and courage) and not so high that it hurts the P&L or creates too great a gap to other executives and the employees.

The good news is the peer group is just one tool we use. We also look carefully at internal executive pay to make sure we are not creating an internal problem, and more importantly at the job the CEO is doing and how he is conquering our strategic objectives.

Most senior executives’ compensation is now made up of three major components – base salary, variable bonus based on company performance and some form of stock (options or RSUs). Having these levers allows the board to align the CEO’s pay directly with the interest of the shareholders – as has happened to most tech companies over the last year there are few bonuses being paid because performance hasn’t been there as a result of the recession.

Of course you do still see companies that offer their CEO compensation that doesn’t seem very aligned to shareholder interest to me: use of the private jet, special healthcare, tax advice, golf club memberships etc – and even a key to the executive washroom. Something I don’t understand but I guess I am an egalitarian when it comes to building company culture.


How to run a Compensation Committee

In addition to running my own board meetings, I am active on two public board compensation committees (one of which I chair) and I’ve come to realize that what goes on in these meetings is often not well understood – and needs demystifying.

The Compensation Committee – I’ll call it the CC from here on – is responsible for all aspects of compensation in the company, and in particular for executive compensation. This means putting the programs and guidelines in place for general employee compensation, and determining and reviewing specific executive compensation.

Running an effective CC is a partnership between the HR team who prepare the programs and models for discussion and the CC members. A CC typically has a chair and two other members – all three should be independent directors – and often the board Chair and other interested board members will sit in and participate.

There is a tremendous quantity of material that the CC has to review and so there are a couple of keys to setting the CC up for success:
First set up an Annual calendar and make sure all major areas of responsibility are covered at least once a year.
– Committee charter
– Employee compensation and benefits programs: base pay guidelines, stock option guidelines, health benefits, ESPP etc.
– Annual bonus program and the company objectives the bonus program is going to be paid against
– Executive compensation: base pay levels, option and RSU levels, objectives and annual bonus
– Executive promotions: discuss and review with the CEO
– CEO compensation – this is often proposed by the CC but finally approved by the board
– Board compensation: Cash and stock compensation plans for board members, the chair and committee members
– Peer group: What other companies does the CC use to compare compensation levels against to make sure the company’s compensation is fair and competitive
– Stock plan, stock pool requirements, overhang levels etc.
– CD&A preparation and review
– Committee self assessment
– Plus any number of administrative items that come up through the year

Because there is such a quantity of material to consider and programs to review it’s important to run the CC meeting in a very organized and transparent way. Make sure every board member is always welcome, ensure that every member of the committee has a chance to speak and contribute and that management and the HR team are also given plenty of opportunity to express their views. And make sure that the minutes of each meeting accurately reflect what’s been covered since they are the legal record of the meeting.

Also, because executive compensation can be very contentious both with employees and with shareholders it is important to make sure the CC is getting good advice on the latest laws, what other companies are doing, and what the latest shareholder concerns are for your type of company. This usually means hiring an outside consulting firm that specializes in compensation and that consults only to the CC and not to the company. This is an important distinction – that way the consulting firm is never conflicted by wanting to curry favor with management because they may not consult to management while consulting to the CC. This is not a hard rule – but I think it’s good business practise to separate out the advice the CC gets from the advice management gets.

And finally, make sure management gets the materials out enough in advance that the committee members can prepare. As the CC chair this usually means I am prepping with the management team and the consultants well in advance so when the materials go out a week in advance they are complete are cover the topics we need to cover.


Companies stop giving guidance – is this a good or a bad move?

In the world of running a public company one of the critical skills a CEO/CFO team used to have to have was the ability to set guidance for the “Street” – that is the sell side analysts who cover their stock and publish research and guidance to investors.

Guidance was typically top line and bottom line, revenue and earnings and the street would come up with a consensus on what EPS (earnings per share) the company would earn in the following quarters – often based on complex models developed in the wee small hours of the night by hard working young analysts.

Setting, and then making guidance worked well for high quality companies – they earned investor trust and were rewarded in the stock price – and the process could also create controversy when, for example Google said it would not provide guidance because the founders did not want to ever sacrifice the long term for a short term reporting need. If you’re Google you could get away with that, but only the rarefied few could, and in the past most would have been crushed by such arrogance.

So what happens now? As reported by MarketWatch, an increasing number of companies like GE and AMD are stopping guidance in the current downturn because they have simply lost good enough visibility to be able to provide it with integrity.

It’s an ethical and practical dilemma. If the CEO doesn’t provide guidance he’s not supporting his investors – one of his key constituencies – and their need to understand the company’s expected performance in order to value to stock. If he does provide guidance and he really doesn’t have enough visibility then he could be misleading his investors (and setting himself up for shareholder lawsuits).

I’m a big believer in transparency and over time that companies will be rewarded for it. Many institutional investors are investing for the long term – more so now than in the recent past – and want and need companies to share the metrics that drive their businesses in order to build their models and understanding. Transparency may not be EPS guidance, but it should be the best information the company can provide to share the outlook management sees. Companies withholding information or being coy about it infuriates investors, as well it should (and even worse is when they miss lead investors by manipulating revenue, as does still happen).

It takes courage for CEOs and CFOs to be transparent and help their shareholders really understand what’s happening to their businesses, but I believe that in the long term – and following the downturn – the CEOs that figure out how to stay transparent will be rewarded.


Hedge fund ethics: “right” and “wrong” in their world

Hedge funds took a battering 2008 – and as they have been battered by the storm two questions of “right” and “wrong” have been coming up that make it sounds like there are ethical codes at work here, but no agreement on what good ethics are.

Some background: There are about 10,000 hedge funds open now, down 4% over the year, but still managing $1.6 trillion dollars. About two thirds lost money in 2008 and of those that did are down an average of 29%. This matters because hedge funds are typically paid both on : 20% of the gains – and on : 2% of the assets under management. High fees (see Henry Blodget’s explanation of the fees here) for which investors expect to get a consistent above market return (until hedge funds systemically move the market, which they clearly do now…). And, more importantly, the hedge fund managers must recoup their losses before they can start collecting fees on the profits again. This could take years – which would mean the managers were only collecting 2% – mouse nuts for many of these guys.

And here’s where the “ethical” questions come up:
If your fund is down and you know it is going to take years to recoup the losses and get paid at 20% of profits again do you:
a) stay with the fund until you have recouped the losses and made your investors whole – working for “psychic income” as Kenneth Griffin of Citadel fame told the New York Times or
b) leave – retire, switch to a new fund, start a few fund – basically start again? If you had many years of excellent performance before this one terrible year you may well be able to raise another fund.

In the first case there’s a moral high ground to climbing back out and keeping your commitments to your investors, but maybe the second case makes sense if you can’t climb back out from that fund. Maybe you can’t keep your key players or your strategy no longer works and your investors are better off with you closing the fund and returning their money.

The second question is whether to allow investors to take money out of the hedge fund. Again hedge funds are not acting consistently. One of your investors wants to pull his money out – do you
a) allow them to knowing that doing so could hurt the remaining investors that are staying in because you’ll be forced to selling into a falling market? Much of the volatility in November and December was redemption selling as hedge funds were force to liquidate equities and debt so investors could withdraw funds. Or do you
b) tell investors they can’t take their money out and you are going to hold it until it is a more stable time to sell?
Again this is a current raging debate in the hedge fund world that takes on the ethical language of right and wrong. I know I’d want to be able to get my money out if I’d lost faith in a fund!

Managing money in this market is incredibly difficult – some would say it’s a crap shoot – and hedge fund performance matters because not only rich people invest in them. Institutions invest in them. Some portion of many regular American’s retirement income is invested into hedge funds through their company or state pension funds. Given the current lack of regulation and transparency, and these grey questions that are unresolved even within the hedge fund community, it’s a given that the new administration is going to put in more regulation.


Risking our best talent

Wall Street will be facing a talent retention challenge very shortly unless the bonus issue is elegantly handled this year.

Over the past week the news has been full of “outrage” and questions about whether bankers should get their bonuses this year. Talk of large chunks of the bailout going to top bankers and class-warfare type language.

But unfortunately this problem is not as simple as the government, or the “public” controlling the pay of an industry they don’t understand. I’m a pretty hard-core democrat and yet when I hear talk of the US taxpayer wanting zero bonuses on Wall Street this year – per a Bloomberg article today – it concerns me that the public doesn’t understand how talent works.

Our best companies are very, very competitive. In all but a very few rare cases, a company is only as good as it’s people. And companies, like fish, rot from the head. It’s a common adage in my world that A players hire A players and B players hire B and C players. Talent is everything. So, in the competitive world of banking it is essential for the long term health of our institutions that they keep the talent, within the institution if at all possible, and definitely within the country. Our best deal-makers will go where the money is and that had better be in the United States and at the institutions that make our financial systems work.

So while I understand that taking public money and using it to pay bonuses may be optically obscene – and it is certainly a good idea for the very top management of the institutions to not take bonuses – if that action is taken too far down there will be a negative backlash – and the talent which is so critical to long term health will leave. There are too many other firms, and countries, that will be happy to hire them.


Valley alarms

Sitting in a London hotel lobby, waiting for my room to be ready, half asleep but reading through my email…. I picked up the Gigaom article Sequoia Rings the Alarm Bell: Silicon Valley Is in Trouble. I had posted a few weeks ago that the valley was not immune, but it seems that people had to see the market crash to get the message.

Clearly Sequoia has see this type of downturn before. The burst of the dot com bubble was much worse for silicon valley than for the rest of the country. Startups went under at an incredible pace. The glory days were over then and there was speculation that the valley was finished, never to recover. (And the side benefit was less traffic and easy restaurant reservations.)

But the doomsayers were wrong. As has happened repeatedly now, a few short years later the valley was booming again with a new generation of heroes like Google and Facebook and the highest number of billionaries outside of Manhattan.

I think the same cycle will repeat. No question this downturn, like the last just 8 years ago, is going to be brutal and we all have to tighten our belts and hunker down to survive it. But the companies that survive will come out the other side much stronger. They’ll have better products, more resilient management teams and the respect of the market for surviving.

It’s my job to make sure FirstRain is one of them.


How to run a board meeting Part 2: In a market crisis

I had written a basic primer on How to run a board meeting nine months ago and have been pleasantly surprised that it continues to be one of the more popular postings. But it’s just the basics and I’ve been working through some more sophisticated challenges recently.

FirstRain sells to both financial services and corporations. Most of our financial services clients are on the buyside, but even the buyside is not immune to the fear running through the markets – and they are reacting to unprecedented volatility so they understandably get distracted. We have been discussing what strategy and tactics to pursue to keep our business growing in difficult times for our customers. And of course this is a subject of great discussion at our board.

We had a regularly scheduled board meeting last week and in preparing two weeks before I found myself consciously stepping back and thinking about how to make the meeting as useful as possible for both FirstRain and the board members given the challenges our financial customers are facing. And this led me to develop a set of additional points on how to run a board meeting in a market crisis.

1. Stay grounded in strategy. You put the strategy in place for a reason but in times of trial not everyone remembers. If you start the discussion with a refresher – what your strategy is and why – and whether any fundamentals have changed that materially impact the strategy – it creates a good grounding for the board discussion. What problem you are solving – who you are solving it for – what market discontinuities you are leveraging and – what products and technology you are building as a result.

2. Review the facts of the crisis – what’s happening, what is the hard evidence and how does it interact with your strategy. Review how your supply chain and/or your customers are affected.

3. Prep the board members for the discussion – as I said in point #6 of my prior post, board members don’t like surprises. Get your agenda out 8-10 days before the meeting, outline what you think needs to be discussed and then call them in advance to make sure you have their input and you get them thinking about the critical issues before they come to the meeting.

4. Make sure you get everyone’s input, especially if you have to make a material decision. If someone can’t come to the meeting ask them to call a few key board members in advance to share their opinion or ask them to send an email summarizing their opinion to the rest of the board.

5. Be clear about what the real choices you face are. Boards do better when you lay out the strategy, the facts around the challenge you are facing and then options A, B or C. That way they can engage and advise you, and while they may come up with an option D which is even better than the choices you gave them you’re more likely to have a productive discussion with some structure.

6. Create opportunities during the meeting to tap into their creativity. If you are trying out new product ideas describe them and use board members experience to help you refine them or break you out of a rut.

In FirstRain’s case our customers need information now more then ever. The CEO and CMO needs to understand the ripple effects of the credit and stock market crunch on their markets and competitors, the portfolio manager needs information in cratering markets even more so than in a bull market. As one of my board members fascetiously said to me – “You should tell prospects it’s irresponsible not to have FirstRain in this environment”. Somehow I don’t think that would be a very effective sales pitch. But revisiting the strategy helped remind us all of the discontinuities that help us: the decline of the sellside will accelerate now, and the web is noisier than ever, making a platform that can create alternative research from the web even more critical.

In the end I believe that unless whatever challenge you are facing changes your fundamental assumptions about your market and solution, unless that is the case you should stay the course with your strategy. Change tactics, try new ideas, but stick with the fundamental strategy. And experienced boards will support you if you are executing and the market needs your product.