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Overview
Drawing on four decades of experience advising boards and CEOs on how to do just that, Thomas A. Cole offers in CEO Leadership a straightforward and accessible guide to navigating corporate governance today. He explores the recurring question of whose benefit a corporation should be governed for, along with related matters of corporate social responsibility, and he explains the role of laws, market forces, and politics and their influence on the governance of public companies. For corporate directors, he provides a comprehensive examination of the roles, responsibilities, and accountability the role entails, while also offering guidance on how to be as effective as possible in addressing both routine corporate matters and special situations such as mergers and acquisitions, succession, and corporate crises. In addition, he offers practical suggestions for CEOs on leadership and their interactions with boards and shareholders. Cole also mounts a compelling case that a corporate culture that celebrates diversity and inclusion and has zero tolerance for sexual misconduct is critical to long-term business success.
Filled with vignettes from Cole’s many years of experience in the board room and C-suite, CEO Leadership is an invaluable resource for current and prospective directors, CEOs, and other senior officers of public companies as well as the next generation of corporate leaders and their business and financial advisors.
Product Details
| ISBN-13: | 9780226665337 |
|---|---|
| Publisher: | University of Chicago Press |
| Publication date: | 11/20/2019 |
| Sold by: | Barnes & Noble |
| Format: | eBook |
| Pages: | 304 |
| File size: | 693 KB |
About the Author
Read an Excerpt
CHAPTER 1
What Is Corporate Governance and Why Do We Care?
The fundamental issue that public company corporate governance addresses is agency cost derived from the dispersion of ownership. When ownership is widely held and liquid (and thus ever-changing), there is a separation of ownership and control. Such a separation creates the risk that "the agent will not always act in the best interests of the principal." This is not at all a new concept. Adam Smith wrote about the separation of ownership and control in The Wealth of Nations in 1776, in the context of joint-stock companies. Berle and Means wrote about it during the Great Depression against a background of the growth of giant companies such as AT&T that, before the growth of institutional shareholders, were extremely widely held.
Even owners with a sizable position in the equity of a corporation may be loath to accept seats on its board. While a seat may allow such an investor to exert some degree of control, it also may come with a price — diminished liquidity resulting from securities laws that prevent buying or selling while in possession of material nonpublic information.
Because agency costs are incurred at the individual firm level, the various definitions of corporate governance take on a decidedly microeconomic orientation. James McRitchie has done a wonderful job collecting definitions of corporate governance — from academics, practitioners, and others. For example, corporate governance is any or all of the following:
• "How investors get the managers to give them back their money."
• "The whole set of legal, cultural, and institutional arrangements that determine what public corporations can do, who controls them, how that control is exercised, and how the risks and returns from the activities they undertake are allocated."
• "The allocation of power within a corporation between its stockholders and its board of directors."
• "[A] field in economics that investigates how to secure/motivate efficient management of corporations by the use of incentive mechanisms, such as contracts, organizational designs and legislation."
• "The relationship among various participants in determining the direction and performance of corporations."
With a special focus on decision making, the following definition provides a framework for much of this book: After determining for whose benefit decisions are to be made, corporate governance is a system for how, and by whom, decisions get made in a corporation and for selecting, compensating, and holding accountable nonowner decision makers.
While corporate governance is important on a microeconomic level, it is important on a macroeconomic level as well. Jonathan Macey at Yale Law School states, "We care about corporate governance because it affects the real economy." The Conference Board has declared that "American economic success depends on establishing an effective system of corporate governance." The Financial Crisis Inquiry Commission reported, "We conclude dramatic failures of corporate governance ... at many systemically important financial institutions were a key cause of [the 2008 global financial] crisis."
One other reason for thinking about the macroeconomic importance of governance is derived from how the ownership of U.S. equities has evolved. According to one estimate, in 2017 more than half of individual citizens held shares either directly as retail investors or indirectly through pension funds, mutual funds, certain types of life insurance products, and ETFs. Stock is owned even by 21 percent of those households that have annual incomes of less than $30,000. In addition, university students and parents of students, recipients of grants from foundations, and those served by other not-for-profits all have an indirect interest in the performance of publicly traded companies because of share ownership by endowments. In 2017, the Federal Reserve reported that U.S. households and nonprofits have a net worth of nearly $100 trillion and that 25 percent of that was represented by directly and indirectly held equities. Because corporate governance affects the performance of the companies in the portfolios of individuals and institutions, governance is a matter of macroeconomic importance.
There is a second macroeconomic effect that may, in part, be attributable to the new era — the decline in the number of U.S. public companies. In 2018, there were 3,671 listed companies, about half the number in 1996 — the early years of the New Era in Governance. "Increases in regulations, shareholder lawsuits and activist demands have ... diminished the appeal of a public listing," and this trend "has benefited private market players at the expense of everyday investors." Another reason for the decline — "Many founders ... believe that private markets are better at allowing them a long-term perspective." As a result of basic economic laws of supply and demand, this trend may also be a cause of increasing stock market valuations for those companies that are public.
CHAPTER 2The Threshold Question of Corporate Governance: For Whose Benefit Are Corporations to Be Governed?
The threshold question for designing a system of corporate governance is this: For whose benefit are corporations to be governed? To use an architectural metaphor, form will follow function. For example, in many countries in Europe, where there is an emphasis on governing for the benefit of employees, the governance structures include two-tier boards — a board of executive directors and a supervisory board. The latter supervises management and has equal numbers of directors elected by shareholders and by employees.
The discussion of the separation of ownership and control and the focus on agency costs foreshadow an answer to this question in the United States that corporations are to be governed for the benefit of the owners — that is, the shareholders. While the primacy of shareholder interests is ultimately the answer that has been arrived at in the U.S., the issue has been the subject of an ongoing policy debate for some time, framed as shareholder versus stakeholder.
In the depths of the Depression, Professors Berle and Dodd conducted a robust debate about "for whose benefit" in the Harvard Law Review. Milton Friedman weighed in on the subject in 1970 with his famous New York Times Magazine article titled "The Social Responsibility of Business Is to Increase Its Profits." The shareholder versus-stakeholder debate continues in the current decade. Professor Lynn Stout of Cornell, writing in 2012, took the position that "the ideology of shareholder value maximization lacks any solid foundation in corporate law, corporate economics or the empirical evidence. ... U.S. corporate law does not impose any enforceable legal duty on corporate directors or executives of public corporations to maximize profits or share price." A similar position was articulated in 2017 by two Harvard Business School professors in an article in the Harvard Business Review. Again, the title says it all — "The Error at the Heart of Corporate Leadership: Most CEOs and Boards Believe Their Main Duty Is to Maximize Shareholder Value. It's Not." And yet, in 2013, Vice Chancellor J. Travis Laster, of the Delaware Court of Chancery, wrote with much greater authority that "the standard of conduct for directors requires that they strive ... to maximize the value of the corporation for the benefit of its residual claimants" — that is, the owners of the common stock.
The debate has no doubt been energized by political leanings and because it is so easy to conflate the question of "for whose benefit" with another question: "to whom does a corporation owe duties"? So, a more complete answer is that corporations are to be governed (and decisions made) for the ultimate benefit of the shareholders, but at the same time, corporations have many duties to other stakeholders (also called the "other constituencies") by way of specific law and regulation as well as contracts. Another formulation is to say that generalized duties (i.e., fiduciary duties) are owed only to the shareholders.
The specific protections of the nonshareholder constituencies are legion. Employees are protected by OSHA, WARN, ERISA, ADA, ADEA, EEOC, FLSA, NLRA, whistle-blower anti-retaliation laws, collective bargaining agreements, employment agreements and state law limitations on noncompetition agreements. Customers are protected by antitrust laws, the FDA, the CPSA, privacy laws, the UCC, tort laws, and contractual warranties. Utility customers are protected by regulations pertaining to rates. Creditors are protected by corporate statutes defining what a "legal dividend" is, fraudulent conveyance laws, the bankruptcy code, and the contractual requirements of their debt instruments, including an implied covenant of good faith. Even "communities at large" have specific protections, such as zoning and environmental laws, as well as safety requirements applicable to utility companies.
The phrase "primacy of shareholder interests" is a fair summary for explaining the structure of U.S. corporate governance and for describing shareholders as the sole beneficiaries of generalized fiduciary duties. That notion certainly applies without exception when a board is considering a sale of the company in a transaction that qualifies as a "change in control." As the Delaware Supreme Court stated in its historic Revlon decision in 1986, "Concern for non-stockholder interests is inappropriate when ... the object no longer is to protect or maintain the corporate enterprise."
The so-called other-constituencies statutes that were adopted post-Revlon Suggest legislative dissatisfaction with a conclusion that shareholder interests are to be the primary consideration of managements and boards. Many states (though not Delaware) have statutes that provide that boards may, in considering corporate actions, take into account the interests of employees, customers, suppliers, and even their communities at large. And some companies have included provisions to the same effect in their certificates of incorporation. These interests are in addition to whatever duties law and contract specifically require, as described earlier. In the absence of historical context, these statutes and provisions might be viewed as progressive and even paternalistic pieces of legislation. Not so. They should be viewed as anti-takeover devices because of the timing of their adoption and because they purport to legitimize consideration of nonshareholders as a basis for rejecting an unsolicited bid. It should also be noted that the constituencies statutes are permissive — they use the word "may," not "must" or "shall." Incidentally, when boards have tried to rely on these statutes to accept a lower-priced offer, it typically does not work. Most courts have held that these statutes do not negate an obligation to seek the best deal, principally based on price (the so-called Revlon obligation discussed later). Shareholders are not likely to approve the lower-priced deal, anyway.
As a guide to directors and officers in the broader context of decision making outside of a change-in-control transaction, the word "primacy" in the phrase "primacy of shareholder interests" should not imply "exclusivity." A more nuanced understanding is required.
At a minimum, primacy means that shareholder considerations cannot be secondary to the interests of other stakeholders. In 1919, in the celebrated dispute between the Ford and Dodge families, the Michigan Supreme Court addressed the "for whose benefit" question as follows: "It is not within the lawful powers of a board of directors to shape and conduct the affairs of a corporation for the merely incidental benefit of shareholders and for the primary purpose of benefiting others."
"Primacy of shareholder interests" does not mean, however, that the interests of other stakeholders (beyond contractual and other legal rights) cannot be considered at all in general D&O decision making: "A board may have regard for various constituencies in discharging its responsibilities, provided there are rationally related benefits accruing to the stockholders." And those benefits need not be immediate.
In an important 1992 article by then Delaware Chancellor William Allen, he first summarizes the two competing policy conceptions of corporations — social entity and property. Under the first view, because corporations (and the limitation of liability afforded to their owners) exist only because of legislative actions of the state, it would be possible for the state to require that they be governed for the benefit of a group broader than simply their owners. In contrast, under the property conception, corporations are simply property, and the interests of their owners are paramount. He goes on to say that, until the advent of contested takeovers in the 1980s, this debate really did not need to be resolved. The competing views could peacefully coexist. When the debate became more consequential in the context of hostile bids, Allen concludes that, because the courts allow boards to focus on the long-term interest of shareholders, just about any action that benefits the nonshareholder constituencies can be justified so long as it ultimately benefits shareholders!
The old-school version of such actions was philanthropy in support of noncontroversial charities and other not-for-profits. In the new millennium, the range of such actions was greatly expanded under the banners of corporate social responsibility (CSR) and environmental, social, and governance (ESG). It is not difficult to justify such actions as ultimately benefiting shareholders, and boards are well advised to consider CSR/ESG as part of corporate strategy. For a consumer products company, CSR/ESG might be viewed as brand building and part of a good marketing strategy. For a public utility, CSR/ESG can be important in the rate-setting context. For a company in just about any industry sector, CSR/ESG can yield benefits in terms of recruiting and retaining employees. In addition, a "good corporate citizen" is more likely to catch a break from the press, regulators, customers, and even juries at a time of a company-originated crisis. Finally, while not all view CSR/ESG the same way, those activities can be attractive to both current and future investors.
Even investors with a singular focus on financial returns advocate attention to nonshareholder stakeholders through CSR or ESG as a means of serving the long-term interests of shareholders. Michelle Edkins, the global head of corporate governance for BlackRock (which in 2018 had $6 trillion in assets under management), had this to say: "We look at [CSR issues] ... not because we are promoting either a social or environmental agenda. We don't have one. The only thing every single one of our clients has asked us to do is generate a return on their assets. We look at environmental and social factors in a business to get a sense of the quality of leadership and the operational excellence within that firm, because in the long term, when companies don't manage what fits under the banner of environmental and social ... that is usually when you have a well blow up or you have a product recall or litigation that costs enormous amounts."
In his 2018 annual letter to CEOs of public companies, BlackRock's CEO Larry Fink took these sentiments a step further — "To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society." (In his 2019 letter, Fink went even further — "Unnerved by fundamental economic changes and the failure of government to provide lasting solutions, society is increasingly looking to companies, both public and private, to address pressing social and economic issues.") The BlackRock message was spotlighted by Barron's in its June 25, 2018, issue (reprinted as a special supplement to the June 26 issue of the Wall Street Journal) titled "Investing with Purpose/Larry Fink's Mission." Fink's 2018 letter triggered many reactions, including an op-ed in the Wall Street Journal by Andy Kessler — the title of which evoked the ghost of Milton Friedman: "Stocks Weren't Made for Social Climbing." Kessler, a hedge-fund manager, called Fink "only the latest to evangelize this [CSR] fad."
Another recent example of the embrace by Wall Streeters of CSR is the ETF launched in 2018 by Goldman Sachs, described as a "feel-good selection of Russell 1000 companies" that score highly on JUST Capital's rankings. Those rankings "score[] businesses using a complex formula related to workers, customers, products, environment, jobs, communities and management." JUST Capital was founded in 2013 by hedge-fund manager Tudor Jones. It recently ranked companies by how much of the 2017 tax cuts would flow through to employees.
Other organizations provide ESG ratings, as well. However, different organizations can give very different ratings to the same company; after all, "they are no more than a series of judgments by the scoring companies about what matters." ESG/CSR ratings have become a part of general performance rankings, as well. The Harvard Business Review's 2018 list of "best performing CEOs" was based on four criteria — three traditional financial measures and an ESG index. The Drucker Institute's Management Top 250 rankings use social responsibility as one of its "five dimensions of corporate performance," with a 23 percent weighting — higher than any other criteria.
There are some who express skepticism about CSR as an investment strategy, citing evidence that it is not a vehicle for achieving superior returns: "Investors are increasingly convinced that they can buy companies that behave better than the rest and make just as much money. They are wrong."
(Continues…)
Excerpted from "CEO Leadership"
by .
Copyright © 2019 Thomas A. Cole.
Excerpted by permission of The University of Chicago Press.
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Table of Contents
IntroductionGlossary of Acronyms
Glossary of Governance Terms of Art
Part I: The Policy, Law, and Market Forces That Have Created the New Era of Corporate Governance
1 What Is Corporate Governance and Why Do We Care?
2 The Threshold Question of Corporate Governance: For Whose Benefit Are Corporations to Be Governed?
3 The Forces That Shape Corporate Governance
Part II: The Board-Centric Corporation
4 The Role of the Board
5 Assembling an Effective Board
6 Duties, Accountability, and Protections of Directors
7 Routine Board Operations
8 Special Situations
9 A Digression on Private Companies, Not-for-Profits, and Congress
Part III: Activism and the Threat of Shareholder-Centricity
10 Activists and Their Goals and Tools
11 The Case against Shareholder-Centricity
Part IV: Challenges to CEO Leadership
12 The Problem
13 Elements of a Solution
Acknowledgments
Appendix 1: Flowchart Illustrating Proxy Voting
Appendix 2: Template for an Oral Board Self-Evaluation
Appendix 3: Template for M&A Agendas
Appendix 4: Primer on Valuation Methodologies
Appendix 5: Summary of Key Percentages
List of Abbreviations in Notes
Notes
Index
About the Author