Corporate Boards: The Human Factor

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What do you do with an expanding young company, led by a visionary founder, when the time comes to replace that visionary with a CEO who has an eye on the “bottom line?”

This and other knotty interpersonal issues, which arise quite commonly in board governance, were explored at the May 12th Boston breakfast meeting of the National Association of Corporate Directors-New England Chapter, by a panel of experienced directors who have served on public and private boards.

Boards may be unskilled in reaching the decision to replace a founding CEO. Particularly in technology-driven companies, boards often are not fully tech-savvy. Then there is the matter of timing; when does the vision become less important than the bottom line?

The panel agreed that the ability of a CEO to impart leadership is more important than the bottom line, because the bottom line will follow good leaders. But you cannot tell if someone is a good leader just by attending a board meeting; it is necessary for the effective director to learn about the company by meeting its personnel, having direct reports to the CEO attend some or all board meetings, and educating yourself to understand the industry in which your company functions.

Terry Carleton, a board member of Demoulas and chair and thereafter president of Bentley University (among other numerous board assignments), added that when you have a board issue of replacing a CEO, this goes hand and hand with the strategic question of where the business is situated. Should you go out of business, sell out, look for a change in leadership? Changing the CEO may be a matter of changing the vision for the business, and that involves evaluating the nature of that vision and the way in which the company fits into emerging marketplaces.

Should the CEO also be the chair of the board? There was unanimous agreement that there are two entirely different jobs and should be separated (although it is difficult sometimes to convince a long-tenured CEO-chairman to step down from the of chair).

What about a fixed retirement age? There seemed to be consensus that a fixed retirement age for a public company is appropriate, although the board will sometimes waive that requirement for people with great skills or institutional knowledge. One panelist observed that although wisdom may reside in senior directors, it is foolish to assume that there aren’t a very large number of competent younger people. No one seemed in favor of a mandatory retirement age for privately held companies.

Finally, it was noted that “older people” are often well-connected, and have robust networks which you can tap to help solve problems quickly, a benefit perhaps not shared by shorter-tenure directors.

What is Free Speech?

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The Supreme Court, by the end of June, must rule whether the State of Texas can refuse to grant a “specialty” license plate to the Sons of Confederate Veterans. Texas has a program to allow the names and logos of groups to appear on license plates. Texas refused to grant this right to the Sons of Confederate Veterans because the Confederate flag would offend some of the population.

Interestingly, the Civil Liberties Union supported the veterans. It is dangerous, said Chief ACLLU attorney Steve Shapiro in remarks delivered May 4th in Boston, to allow states to pick and choose those elements of speech which it will, and will not, permit to appear, even on its own license plates. Yet another case of “I don’t like what you are saying but you have a constitutional right to say it.”

Note that the Civil Liberties Union has a case against North Carolina, which permits license plates to proclaim that the driver is “pro-life” but not that the driver “respects choice.”

In a separate case just decided, a husband put potentially threatening material into rap lyrics, directed against his estranged wife, and posted those lyrics on the internet. The First Amendment does not protect a threat, but what is the definition of a threat? How do you know?

The general rule is an objective test: would a reasonable person feel threatened? The Civil Liberties Union had argued that you must also apply a second test: what was the subjective motivation of the person delivering the “threat;” you don’t want to leave the determination of what is, and what is not, a threat to the government based solely on content, as that fosters de facto censorship.

Interesting sidelight: does posting the speech on the internet make it more threatening (because it is generally circulated and well known) or less threatening (everyone knows that people say whatever they want on the internet which is the Wild West of communications).

Finally, in a third case now pending, Florida law prohibits judicial candidates (they elect their judges down there) from soliciting their own contributions. They can give their contribution list to their election committee, and if someone donates they can send a personal thank you note, but they can’t send out the solicitation letter itself.

The Supreme Court has just upheld that law (and the prohibition) by a 5-4 vote, with conservative Chief Justice Roberts joining the four most liberal members of the bench. Is it constitutionally permissible to prevent a candidate for office from exercising his or her right to speak by soliciting donations? The Supreme Court thinks so at least for judges. The interest in keeping the judiciary untainted was found to be a higher government interest justifying governmental restriction of the candidate’s political speech.

One could find this an odd decision; the sanctity of the judiciary may be fundamentally compromised by electing judges in the first place.

Same Sex marriage in the Supreme Court

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Last Tuesday, the Supreme Court heard appeals from a decision which supported bans against same sex marriage in four states.  The questions were: does the Constitution require all states to license same sex marriages and, if not, must a state honor such a marriage which occurred under the law of another state?

The constitutional issue is whether marriage is a fundamental right which cannot be denied.  It is not so easy, however:  if it is a fundamental right, how is that right defined?  Is it a right for all people, or only for people marrying the other sex?  Does the right encompass polygamy?  Is the case really just a simple matter of sexual discrimination: Jim can marry Jane but cannot marry Joe?  Are Jim and Joe being discriminated against?

According to chief counsel to ACLU, the arguments before the Justices were surprisingly unsophisticated, akin the discussion you might have with a friend over beers.   That is unfortunate as the cases should turn on constitutional issues, not on simple majority vote of who believes, and who does not believe, in a particular result. You don’t vote on fundamental rights.  As Justice Kagan has said: “We do not live in a democracy.  We live in a constitutional democracy.”

Highlight (or lowlight) of the argument: the attorney arguing for the states in support of same sex marriage bans observed that marriage is a fundamental right only between people of the opposite sex which is designed to have children raised properly by their natural parents.  I wonder whether Chief Justice Roberts squirmed at that notion, underneath his robes; all of his children are adopted.

Death and the Supreme Court

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Last Wednesday, the U. S. Supreme Court heard the so-called “Death Penalty Case,” wherein prisoners on death row were claiming that the manner of death administered (in those jurisdictions which still had the death penalty) constitutes prohibited cruel and unusual punishment under the 8th Amendment to the Constitution.

The case is curious, according to Steve Shapiro, legal director of the American Civil Liberties Union, in remarks delivered May 4th here in Boston. Generally (this paragraph is not for the weak of stomach), execution by drugs is effected through a three drug cocktail and the first drug is an anesthetic which is designed to prevent the last step from being incredibly painful. Fearing consumer back-lash, the company that has provided the anesthetic has now refused to produce it for lethal injection purposes. The now-proposed substitute is a barbiturate not prescribed for elimination of intense pain.

From the conservative side of the aisle, Justice Alito noted that our society simply must have the technology to kill people painlessly, citing assisted suicides. Justice Scalia blamed the unavailability of the drug on an “abolitionist movement” of anti-death-penalty activists that has kept it off the market; he apparently was disturbed that people on death row should seek to bar a particular method of execution because certain other people’s actions have made that drug unavailable.

Entrepreneurship

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How do entrepreneurs create value? By finding a market space that is ripe for disruption, and then applying “leverage” to that space.

What is the key to a successful start-up? “Market Selection:” figuring out what you are selling, to whom you are selling it, and when.

Serial entrepreneur Andy Ory, who sold Acme Packet to Oracle for a couple of billion dollars in 2013, expounded on the essence of entrepreneurship at the April 30th Boston breakfast meeting of the Association for Corporate Growth. Ory is now working at his new company, with twenty-five employees (mostly engineers), financing and, so far, “no product.”

Why do entrepreneurs do this, and why do they act independently and why cannot entrepreneurship flourish within larger, well financed companies (the kinds of companies that often purchase the successful entrepreneurship projects)? According to Ory, “entrepreneurs don’t make good employees.” Many large companies have tried internal innovation, and almost all have failed (he noted Google as a possible exception that proves the rule).

What sort of resources do budding entrepreneurs need? Since successful market selection, Ory’s key to value creation, requires experience and context and a robust network to tap into, he thinks that budding entrepreneurs should be provided with meaningful internships. Perhaps universities can set up internships which will facilitate creation of a dynamic network, thus informing the market selection process.

New Disclosures of Executive Comp

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The Wall Street Journal this morning (April 29th) reports that the SEC is proposing new regulations requiring further substantial disclosure of executive compensation, as mandated by the 2010 Dodd-Frank Act.  (Note: SEC releases now confirm….)

Although the proposals will require disclosure both for the CEO and the five highest paid executives, and will track the disclosure over a five year period, the devil as ever will be in the details. It looks like some new measures of compensation are involved. For example, calculation for the five highest paid executives is set to exclude certain components otherwise reported in existing SEC requirements, such as the value of share grants that have not yet vested.

Disclosure also will attempt to tie actual pay to “total shareholder return,” a measure companies are already required to disclose in proxy statements.

The proposed rules will be subject to public comment and perhaps modification. They do not appear to be responsive to the as-yet-unfulfilled Dodd-Frank requirement of expressing the ratio between CEO compensation and the compensation of all employees; the SEC proposed rules in that regard in 2013 (again, years late as against the statutory requirement), but the SEC is not expected to finalize those highly convoluted (and likely non-edifying)  ratio rules at least until the second half of 2015.

All of this regulation of course begs the question of the efficacy of disclosure tools in the actual control of “excessive” executive compensation. The previously adopted “say-on-pay” regulations, much touted, have done little to control executive comp. Boards of directors are slow to admit psychologically that they are hiring people who are in the lower half of the quality scale (implicitly equating compensation with executive ability). Whether these new public disclosures, if and when finally adopted, will be effective is highly problematical; indeed, calculation of CEO compensation as against shareholder return already is being deeply analyzed by activist investors based upon information now calculable under the current disclosure regime.

It may be that activist shareholders, together with shareholder advisors such as ISS, ultimately will be the drivers for any capping of CEO or executive compensation.

Trends in Managing Cyber Risk

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Although cyber risk typically is cited as the biggest board preoccupation in terms of risk, at least among public and larger companies, other data suggests that preoccupation with cyber risk is over-stated.

According to the World Economic Forum (2015 study), the ten top “global risks” in order of likelihood places cyber-attacks tenth, well behind inter-country conflicts, collapses of national governments, extreme weather and the water crisis. And, in terms of impact, cyber-attacks do not even make the list of the top ten (water, infectious diseases and WMDs lead the list).

On the other hand, public boards (2015 NACD survey) indicate that at least one-third of all United States public directors consider the quality of information concerning cyber security, delivered by management, to be unsatisfactory, and a majority consider information quantifying that risk to be unsatisfactory.

Where do public companies place responsibility for risk oversight? During the last couple of years, one suspected a trend in designating specific Risk Committees. However, at the public company level, the audit committee continues by far to be the typical depository of that function. If there is any trend, it is towards placing ERM responsibility on the full board of directors, and not at any committee level.

Cyber Cooperation, Company Liability and Privacy

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Yesterday I posted about House of Representatives action encouraging companies to share with the Federal government information bearing on cyber security.  Intrigued by substantial negative votes cast against what looked much like a no-brainer, I sought some texture on the issue from Congressman Mike Capuano (D– MA and a thoughtful liberal voice in the Congress).  Mike’s Newsletter, received today, is pretty interesting.

It seems there were two separate House bills which were passed and Mike voted against both.  The first (Protecting Cyber Networks Act) requires the Director of National Intelligence to establish a framework for sharing company cyber breach information while including consumer privacy protections.  In order to foster company participation, there are strong insulations against company liability for sharing private data with whichever Federal agency,  in the company’s view,  is best equipped to analyze the issue.  However, under the bill, that Federal agency must immediately share the information with the Department of Defense and the National Security Agency.  This bill passed 307-116 with overwhelming Republican support and mixed Democratic support (105 yeas, 79 Democratic nays).

A second related bill garnered far more robust support on both sides of the aisle, requiring companies to take “reasonable efforts” to remove personal information.  It also establishes Homeland Security Department’s National Cybersecurity and Communications Integration Center as the lead Federal civilian agency on cyber threats.

Both bills worried Capuano relative to inadequate consumer protection.  Perhaps part of the concern is the interweaving of the US response to cyber threats with sensitivity to international governmental participation in domestic US hacking.  The existing infrastructure already is keyed significantly to this risk, involving the FBI, Homeland Security and Immigration with significant anti-cyber-risk functions.  The tension between protecting us against the potential of massive damage from off-shore and creating a hyper-intrusive governmental bureaucracy, already pervading the debate as to free speech issues over the internet and our phone system, now is evident even in the effort to protect our business computer networks.  This is not an area where clear guidelines will be generated any time soon.

Congressional Action on Cyber-Threats

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The Times today reports that the House has passed a broad measure encouraging companies to open their networks and records to Federal investigators of cyber breaches.  Since the Senate Intelligence Committee has recommended a similar measure and since the Administration seems on board, we may be seeing legislation soon.

In broad outline, companies would be protected from liability for disclosure, but only provided that their data is scrubbed of personal information. Resistance historically has been expressed by Republicans worried about government burdens on business and by fears from all over the spectrum that giving more data to the government is just never a good idea; the liberal Massachusetts House delegation was pretty split in voting on the House Bill (which passed by a three-to-one margin).

Income Inequality: Big Problem, But What to Do?

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Income inequality in the United States is recognized as a worsening significant issue.  At a recent meeting of the Columbia University Alumni Association (held in the austere richness of Boston’s Algonquin Club), Economics Professor Sunil Gulati, and politically liberal chief investment officer of Sankaty Advisors Jonathan Lavine, speculated about how to address it. The bad news is that suggestions were short on specifics and avoided any discussion of  economic measures which might promptly mitigate at least the trend if the not the status quo.  Emphasis on needs-blind university education for talented students and mention of reforming immigration policies to keep US-educated foreign graduates in the United States (rather than forcing them to go home and take their expertise and entrepreneurial drive with them) are both fine ideas, but are long-term structural elements unlikely to have short-term results and unlikely to create public assurance that the basic issue is being addressed directly. Of course a specific discussion of governmental involvement, by regulation or tax policy, would be highly volatile.  Congress, in addressing the issue, charged the SEC with forcing disclosure of executive salaries, through more robust discussion of compensation and advisory “say on pay” votes by shareholders, and did not either attack income disparity through tax policy (beyond the modest existing provisions of IRC section 162[m] which limit CEO comp deductibility in certain instances) or through admittedly un-American absolute caps on earnings or through robust national hourly wage minimums. It is likely too much to ask major investors in business, obligated to their own stake-holders to produce robust returns, to make fostering of income equality a checklist item when deploying capital, and no one raised that issue with the panel (Lavine runs Sankety which is an investment affiliate of Bain), but if money talks then one quick way force the issue is to build the goal of income equality into the criteria for investment.  Not a likely development….