Columbia Law School Roundtable on A Governance Research Agenda for the Academy

Since Jensen and Meckling's formulation of the theory of “agency costs” in 1976, corporate finance and governance scholars have produced a large body of research that attempts to identify the most important features and practices of effective corporate governance systems. But for all the research that has been done in the past 40 years, many practitioners continue to see a disconnect between theory and practice, between the questions researched and the questions that need to be answered. In this roundtable, Martijn Cremers begins by challenging the conventional view that limiting “agency costs” is the main challenge confronted by boards of directors in representing shareholder interests and, hence, the proper focus of most governance scholarship. Especially in today's economy, with the high values assigned to growth companies, the most important function of corporate governance may instead be to overcome the problem of American “short termism” that he attributes to “inadequate shareholder commitment to long‐term cooperation.” And he buttresses his argument with the findings of his own recent research suggesting that obstacles to the workings of the corporate control market like staggered boards and supermajority voting requirements may actually improve long‐run corporate performance by lengthening the decision‐making horizon of boards and the managements they supervise. Vik Khanna discusses Indian Corporate Social Responsibility (CSR) spending and its effects in light of a recent law requiring Indian companies of a certain size to devote at least 2% of their after‐tax profit to CSR initiatives. One unintended effect of this mandate, which took effect in 2010, was that all Indian companies that were spending more than the prescribed 2% of profits cut their expenditure back to that minimum, suggesting that CSR and advertising are substitutes to some extent, and that such legal mandates can discourage CSR spending by early adapters or “leaders.” Nevertheless, Khanna also found evidence of social norms developing in support of CSR, including a spreading perception that such spending can help some companies achieve strategic goals. Jeff Gordon closes by arguing that, to the extent investors are short‐sighted, their short‐sightedness is likely to be justified by their recognition that public company directors have neither the information nor the incentives to do an effective job of monitoring corporate managements. The best solution to the problems with U.S. corporate governance is to replace today's “thinly informed” directors with “activist” directors who more closely resemble the directors of private‐equity owned firms. Such directors would spend far more time with, and be much more knowledgeable about, corporate management and operations—and they would have much more of their personal wealth at stake in the form of company stock.     

The Role of Corporate Boards: A Roundtable Discussion of Where We're Going and Where We've Been

In this roundtable that took place at the 2016 Millstein Governance Forum at Columbia Law School, four directors of public companies discuss the changing role and responsibilities of corporate boards. In response to increasingly active investors who are looking to management and boards for more information and greater accountability, the four panelists describe the growing demands on boards for both competence and commitment to the job. Despite considerable improvements since the year 2000, and especially since the 2008 financial crisis, the clear consensus is that U.S. corporate directors must become more like owners of the corporation who “truly represent the long‐term interests of all of the shareholders.” But if activist investors appear to pose the most formidable new challenge for corporate directors—one that has the potential to lead to shortsighted managerial decision‐making—there has been another, less visible development that should be welcomed by wellrun companies that are investing in their future growth as well as meeting investors’ expectations for current performance. According to Raj Gupta, who serves on the boards of HewlettPackard, Delphi Automotive, Arconic, and the Vanguard Group,

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A CEO's Playbook for Creating Long‐Term Value: Ten Essential Resource Allocation Practices

A former CEO of a large and successful public company teams up with a former chief investment strategist and a well‐known academic to suggest ten practices for public companies intent on creating long‐run value:

1. Establish long‐term value creation as the company's governing objective.
2. Ensure that annual plans are consistent with the company's long‐term strategic plan.
3. Understand the expectations embedded in today's stock price.
4. Conduct a “premortem”—and so gain a solid understanding of what can go wrong—before making any large capital allocation decisions.
5. Incorporate the “outside view” in the strategic planning process.
6. Reallocate capital to its highest‐valued use, selling corporate assets that are worth more to or in the hands of others.
7. Prioritize strategies rather than individual projects.
8. Avoid public commitments, such as earnings guidance, that can compromise a company's capital allocation flexibility.
9. Apply best private equity practices to public companies.
10. CEOs should work closely with their boards of directors to set clear expectations for creating long‐term value.

These practices, as the authors note in closing, “are meant to provide a starting point for public companies in carrying out their mission of creating long‐run value—and in a way that earns the respect, if not the admiration and support, of all its important stakeholders.”     

Session III: Securities Law in Twenty‐First Century America: A Conversation with SEC Commissioner Robert Jackson

SEC Commissioner Robert Jackson comments on three major issues the Commission has been investigating: (1) the concentration of ownership among American stock exchanges; (2) the extent of common ownership of, and potential for undue influence over, U.S. corporations by large institutional shareholders; and (3) the role of corporate boards in promoting and protecting stakeholder interests as well as shareholder interests. In the first of the three areas, Jackson argues that the ownership of 12 of the 13 U.S. stock exchanges by just three financial conglomerates suggests a competitiveness problem— one that, despite the significant reductions in trading costs during the last 15 years, should receive further investigation. To the concerns raised by the common and increasingly concentrated ownership of U.S. public companies by institutional shareholders, the Commissioner's main response is to note that whatever culpability corporate America is forced to assume for our large and growing environmental and social problems must be shared with the largest U.S. institutional shareholders, whose collective resources and influence confer a responsibility to help guide companies when responding to such problems. Finally, on the issue of stakeholder theory and ESG, Jackson insists that asking corporate boards to put the interests of all stakeholders on a par with their shareholders’ when making strategic business decisions would be a mistake. Besides creating a major accountability problem, the adoption of stakeholder theory in place of “the clear, single‐minded objective function of increasing long‐run shareholder value” would deprive boards of their principal guide “when making the difficult tradeoffs among stakeholders that effective oversight and management of public companies require.”     

U.S. Corporate Governance: Accomplishments and Failings A Discussion with Michael Jensen and Robert Monks

Two of America's most prominent shareholder activists discuss three major issues surrounding the U.S. corporate governance system: (1) the case for increasing shareholder “democracy” by expanding investor access to the corporate proxy; (2) lessons for public companies in the success of private equity; and (3) the current level and design of CEO pay. On the first of the three subjects, Robert Monks suggests that the U.S. should adopt the British convention of the “extraordinary general meeting,” or “EGM,” which gives a majority of shareholders who attend the meeting the right to remove any or all of a company's directors “with or without cause.” Such shareholder meetings are permitted in virtually all developed economies outside the U.S. because, as Monks goes on to say, they represent “a far more efficient and effective solution than the idea of having shareholders nominate people for the simple reason that even very involved, financially sophisticated fiduciaries are not the best people to nominate directors.” Moreover, according to both Jensen and Monks, corporate boards in the U.K. do a better job than their U.S. counterparts of monitoring top management on behalf of shareholders. In contrast to the U.S., where the majority of companies continue to be run by CEO/Chairmen, over 90% of English companies are now chaired by outside directors, contributing to “a culture of independent‐minded chairmen capable of providing a high level of oversight.” In the U.S., by contrast, most corporate directors continue to view themselves as “employees of the CEO.” And, as a result, U.S. boards generally fail to exercise effective oversight and control until outside forces—often in the form of activist investors such as hedge funds and private equity—bring about a “crisis.” In companies owned and run by private equity firms, by contrast, top management is vigorously monitored and controlled by a board made up of the firm's largest investors. And the fact that the rewards to the operating heads of successful private equity‐controlled firms are typically multiples of those received by comparably effective public company CEOs suggests that the problem with U.S. CEO pay is not its level, but its lack of correlation with performance.     

An Investor Perspective on the Black Box of Corporate Social Responsibility

In summarizing the findings of their recent study, the authors report findings that suggest that not all socially responsible corporate policies are likely to have the same effect on a company's ownership and value. Using environmental policy as their proxy for CSR activities, the authors classify corporate environmental practices into two categories: (1) actions that reduce the likelihood of harmful outcomes by reducing the corporate exposure to environmental risk; and (2) actions that enhance companies' perceived ‘greenness’ through investments that go beyond both legal requirements and any conceivable risk management rationale. Although both groups of environmental practices are likely to be viewed as socially beneficial, corporate expenditures that reduce a firm's environmental risk exposure are more likely to benefit shareholders by limiting the risk of losses arising from environmental accidents, lawsuits, and fines—and possibly thereby reducing the firm's cost of capital. By contrast, corporate expenditures that enhance the firm's perceived greenness by going beyond legal requirements and risk management rationales could actually reduce shareholder value. Consistent with this hypothesis, the authors find that institutional investors tend to own smaller than average percentages of both companies the authors identify as ‘toxic’ and make limited efforts to manage their environmental risk, and companies they label ‘green’ with low environmental risk exposure but relatively high CSR spending on the environment. At the same time, such investors hold larger‐than‐average positions in ‘neutral’ companies with relatively low, or effectively managed, environmental risk exposures and limited investment in ‘greenness’ programs. The authors also find that both toxic and green companies have lower (Tobin's Q) valuations than neutral companies, and that otherwise toxic companies that effectively manage their environmental risk exposures have higher valuations.     

The Icahn Manifesto

The title of this opening chapter in the author's new book on activist investors refers to Carl Icahn's solution to the “agency” problem faced by the shareholders of public companies in motivating corporate managers and boards to maximize firm value. During the 1960s and '70s, U.S. public companies tended to be run in ways designed to increase their size while minimizing their financial risk, with heavy emphasis on corporate diversification. Icahn successfully challenged corporate managers throughout the 1970s and 1980s by buying blocks of shares in companies he believed were undervalued and then demanding board seats and other changes in corporate governance and management. This article describes the evolution of Icahn as an investor. Starting by investing in undervalued, closed‐end mutual funds and then shorting shares of the stocks in the underlying portfolio, Icahn was able to get fund managers either to liquidate their funds (giving Icahn an arbitrage profit on his long mutual fund/short underlying stocks position) or take other steps to eliminate the “value gap.” After closing the value gaps within the limited universe of closed‐end mutual funds, Icahn turned his attention to the shares of companies trading for less than his perception of the value of their assets. As the author goes on to point out, the strategy that Icahn used with such powerful effect can be traced to the influence of the great value investor Benjamin Graham. Graham was a forceful advocate for the use of shareholder activism to bring about change in underperforming—and in that sense undervalued—companies. The first edition of Graham's investing classic, Security Analysis, published in 1934, devoted an entire chapter to the relationship between shareholders and management, which Graham described as “one of the strangest phenomena of American finance.”     

Far Beyond the Quarterly Call: CECP's First CEO‐Investor Forum

The authors begin by describing how the existing structure of corporateshareholder communications encourages short‐term planning and performance evaluation horizons. Then, after summarizing the substantial evidence that corporate management, boards, and investors are concerned about the failure of current corporate‐shareholder communications to reflect longer‐run corporate investment and its expected payoffs, the article holds up the long‐run plans presented by the CEOs of five large public U.S. companies (and the CFO of IBM) at the first ever CECP CEOInvestor Forum as providing a promising model for the future. Such presentations are also evaluated against a set of criteria the authors propose for assessing the effectiveness of those presentations—criteria that were developed through extensive investor and CEO feedback. The article concludes by discussing the three main programs that make up CECP's Strategic Investor Initiative to further the development of such longterm plans. One program is focused on identifying different kinds of investors, with the aim of helping management attract longer‐term shareholders. A second program is designed to improve the ways companies communicate with their non‐investor stakeholder groups, with particular emphasis on The Statement of Material Audiences and its role in identifying the critical stakeholders and their contributions to the long‐run success of the company. Third and last is the development of a common language and tool‐kit for longterm plans, with the aim of bringing about the broad adoption of longterm plans as a mainstream element in corporate‐shareholder communications.     

An insider's call for outside direction

The large public corporation has been an unrivaled creator of wealth and jobs in our century. But public corporations depend on patient capital, and patient capital depends on boards of directors that are conscientious and responsible. Unfortunately, the prosperity and economic stability of the last 50 years have allowed boards to grow complacent, clubby, and passive. Now explosive developments in five areas have shaken the corporate world to its roots: information technology, flexible manufacturing, global markets, workplace democracy, and pension-fund capitalism. As a result, large corporations find themselves under attack from a hornet's nest of small, aggressive competitors, and at the same time, professional investors and the constant threat of takeover have forced corporations to focus on short-term results rather than on long-term investments. Although pension funds ought to behave like any other patient capital, the fact is we cannot count on institutional investors to buy stock for the long term and to hold a board's feet to the fire to protect their investments. One reason is legal. Securities laws hinder stockholders from working together to make their weight felt with boards of directors. So they tend to vote with their feet instead and sell the stock when unhappy with management. The author recommends a variety of measures to reinvigorate corporate boards, reduce their fear of fiduciary liability in the investment of pension-fund monies, and encourage pension-fund investors to take a more active role in the direction of the companies whose stock they own.     

Corporate Governance and the Cost of Capital: Evidence from Australian Companies

The authors examine a sample of large Australian companies over a 10‐year period with the aim of analyzing the role that firm‐level corporate governance mechanisms such as insider ownership and independent boards play in explaining a company's cost of capital. The Australian corporate system offers a unique environment for assessing the impact of corporate governance mechanisms. Australian companies have board structures and mechanisms that are similar in design to Anglo‐Saxon boards while offering a striking contrast to those of German and Japanese boards. At the same time, however, the Australian market for corporate control is much less active as a corrective mechanism against management entrenchment than its U.S. and U.K. counterparts, making the role of internal governance mechanisms potentially more important in Australia than elsewhere. The authors report that greater insider ownership, the presence of institutional blockholders, and independent boards are all associated with reductions in the perceived risk of a firm, thereby leading investors to demand lower rates of return on capital. In so doing, the study provides evidence of the important role of corporate governance in increasing corporate values.     

The Labor Market for Directors and Externalities in Corporate Governance

This paper studies how directors' reputational concerns affect board structure, corporate governance, and firm value. In our setting, directors affect their firms' governance, and governance in turn affects firms' demand for new directors. Whether the labor market rewards a shareholder‐friendly or management‐friendly reputation is determined in equilibrium and depends on aggregate governance. We show that directors' desire to be invited to other boards creates strategic complementarity of corporate governance across firms. Directors' reputational concerns amplify the governance system: strong systems become stronger and weak systems become weaker. We derive implications for multiple directorships, board size, transparency, and board independence.     

The Purpose of the Firm,Valuation, and the Management of Intangibles

This article provides a different way of thinking about, and responding to, four important issues that confront most public companies. First, in articulating the overarching corporate purpose, the author suggests a middle ground between shareholder value maximization and stakeholder theory that aims to achieve the end result of value maximization while taking a “holistic” view that meets most of the demands of stakeholder advocates. As described by the author, there are four critical steps for management and boards in creating such companies: (1) communicating a vision of the company and its purpose to employees as well as investors (and other key outsiders); (2) organizing to survive and prosper through efficiency and innovation; (3) working continuously to develop win‐win relationships with stakeholders and other companies; and (4) taking care of the environment and future generations. Second, in thinking about the corporate purpose and how to evaluate success in achieving it, managements and boards need a valuation model that provides a clear and insightful connection between long‐term corporate performance and market valuation, and how both might be expected to change as the firm matures. A strong case is presented for the life‐cycle valuation model, widely used by money management organizations, in which a company's projected cash flows reflect an expected “fade” in both economic returns on capital and reinvestment rates. The potential uses of this model are illustrated using lifecycle corporate performance data for 3M during the past 50 years. Third, in an effort to capture the value of innovation and investment in intangible assets, the author presents an alternative to the accounting approach of capitalizing and amortizing such assets that attempts to capture their expected future benefits by using more favorable forecasts of long‐term fade rates. Fourth, the author shows how incorporating Life‐cycle Reviews for each of a company's business units as part of its Integrated Reporting could improve management's resource allocation decisions, help build a shareholder base of long‐term investors, and provide management with the support and confidence to resist Wall Street's excessive emphasis on quarterly earnings.     

The Growing Executive Compensation Advantage of Private Versus Public Companies

Private companies have a natural governance advantage over public companies—one that stems mainly from the presence on their boards of their largest owners. This governance advantage is reflected in the greater effectiveness of private company executive pay plans in balancing the goals of management retention and incentive alignment against cost. Private company investor‐directors are more likely to make these tradeoffs efficiently because they have both a much stronger interest in outcomes than public company directors and more company‐specific knowledge than public company investors. Furthermore, private company boards do not have to contend with the external scrutiny of CEO pay and the growing number of constraints on compensation that are now faced by the directors of public companies. Such constraints focus almost entirely on one dimension of compensation governance—cost—in the belief that such constraints are required to limit the ability of directors to overpay their CEOs. In practice, any element of compensation can serve to improve retention or alignment, as well as being potentially costly to shareholders. Furthermore, any proscribed compensation element can be “worked around” by plan designers, provided the company is willing to deal with the complexity. For this reason, rules intended to deter excessive CEO pay are now effectively forcing even well‐intentioned public company boards to adopt suboptimal or overly complex compensation plans, while doing little to prevent “captured” boards from overpaying CEOs. As a result, it is increasingly difficult for public companies to put in place the kinds of simple, powerful, and efficient incentive plans that are typically seen at private companies—plans that often feature bonuses funded by an uncapped share of profit growth, or upfront “mega‐grants” of stock options with service‐based vesting.     

Do Board Characteristics Influence the Shareholders' Assessment of Risk for Small and Large Firms?

This paper investigates the association between board characteristics and shareholders' assessment of their exposure to economic and agency risks as reflected in the volatility of stock returns. Our hypotheses incorporate prior evidence that small and large firms have ‘dramatically’ different board structures, reflecting the firms' different monitoring and advising needs. We hypothesize and find evidence that only the shareholders of well‐established large firms are able to generate positive net benefits, in the form of lower equity risk, from independent boards and well‐connected independent directors with multiple directorships. We also find professional and formal industry degree qualifications on the board are associated with shareholders' risk assessment for some small firms consistent with the focus of small firms on building growth and scale. While we find evidence that formal industry professional affiliations (weak evidence) and MBAs provide benefits for the shareholders of large firms, there is limited evidence that financial expertise on the board systematically influences shareholders' risk assessments for small or large companies. The key conclusion from the evidence in this paper is that a ‘one size fits all’ approach to governance in relation to the board of directors may not meet the diverse needs of companies at different stages of economic development.     

UNIVERSITY OF GEORGIA ROUNDTABLE ON: Enterprise‐Wide Risk Management

For many years, MBA students were taught that there was no good reason for companies that hedge large currency or commodity price exposures to have lower costs of capital, or trade at higher P/E multiples, than comparable companies that choose not to hedge such financial price risks. Corporate stockholders, just by holding well‐diversified portfolios, were said to neutralize any effects of currency and commodity price risks on corporate values. And corporate efforts to manage such risks were accordingly viewed as redundant, a waste of corporate resources on a function already performed by investors at far lower cost. But as this discussion makes clear, both the theory and the corporate practice of risk management have moved well beyond this perfect markets framework. The academics and practitioners in this roundtable begin by suggesting that the most important reason to hedge financial risks—and risk management's largest potential contribution to firm value—is to ensure a company's ability to carry out its strategic plan and investment policy. As one widely cited example, Merck's use of FX options to hedge the currency risk associated with its overseas revenues is viewed as limiting management's temptation to cut R&D in response to large currency‐related shortfalls in reported earnings. Nevertheless, one of the clear messages of the roundtable is that effective risk management has little to do with earnings management per se, and that companies that view risk management as primarily a tool for smoothing reported earnings have lost sight of its real economic function: maintaining access to low‐cost capital to fund long‐run investment. And a number of the panelists pointed out that a well‐executed risk management policy can be used to increase corporate debt capacity and, in so doing, reduce the cost of capital. Moreover, in making decisions whether to retain or transfer risks, companies should generally be guided by the principle of comparative advantage. If an outside firm or investor is willing to bear a particular risk at a lower price than the cost to the firm of managing that risk internally, then it makes sense to lay off that risk. Along with the greater efficiency and return on capital promised by such an approach, several panelists also pointed to one less tangible benefit of an enterprise‐wide risk management program—a significant improvement in the internal corporate dialogue, leading to a better understanding of all the company's risks and how they are affected by the interactions among its business units.     

Liability Risk for Outside Directors: a Cross‐Border Analysis

Much has been said recently about the risky legal environment in which outside directors of public companies operate, especially in the USA, but increasingly elsewhere as well. Our research on outside director liability suggests, however, that directors’ fears are largely unjustified. We examine the law and lawsuit outcomes in four common law countries (Australia, Canada, Britain, and the USA) and three civil law countries (France, Germany, and Japan). The legal terrain and the risk of ‘nominal liability’(a court finds liability or the defendants agree to a settlement) differ greatly depending on the jurisdiction. But nominal liability rarely turns into ‘out‐of‐pocket liability,’ in which the directors pay personally damages or legal fees. Instead, damages and legal fees are paid by the company, directors’ and officers’(D&O) insurance, or both. The bottom line: outside directors of public companies face a very low risk of out‐of‐pocket liability. We sketch the political and market forces that produce functional convergence in outcomes across countries, despite large differences in law, and suggest reasons to think that this outcome might reflect sensible policy.     

Are Busy Boards Effective Monitors?

Firms with busy boards, those in which a majority of outside directors hold three or more directorships, are associated with weak corporate governance. These firms exhibit lower market‐to‐book ratios, weaker profitability, and lower sensitivity of CEO turnover to firm performance. Independent but busy boards display CEO turnover‐performance sensitivities indistinguishable from those of inside‐dominated boards. Departures of busy outside directors generate positive abnormal returns (ARs). When directors become busy as a result of acquiring an additional directorship, other companies in which they hold board seats experience negative ARs. Busy outside directors are more likely to depart boards following poor performance.     

Risk Management,Corporate Governance,and the Search for Long-Term Investors

This discussion explores a number of ways that more effective risk management, corporate governance, and communication with investors can help companies increase their effciency and long-run value. According to one of the panelists, recent surveys of corporate directors suggest that companies should devote more time and attention to three issues—strategy, risk management, and succession planning—and that strategy and risk are the “flipsides of the same coin.” As the panelist argues, “You can't talk about strategy without talking about what risks you're going to take—and what risks you decide to take has to depend on the core competencies that drive the corporate strategy.” In addition to making risk management a critical part of corporate strategy, another notable recommendation is to communicate a company's strategy and business plan as clearly as possible to investors, with the aim of attracting more sophisticated, long-term shareholders. Contrary to popular belief, such a group may well include some hedge funds and other activist shareholders. According to a newly released report on shareholder activism (produced and cited by another panelist), corporate boards should work harder to identify and engage the “largest 10 shareholders in the organization,” with the ultimate goal of cultivating a shareholder base that buys into the company's strategy.     

A survey of corporate perceptions of short-termism among analysts and fund managers

There is a popularly held view that institutional investors and stockbrokers' analysts take a short-term view when making or advising on investment decisions. Short-termism is held to be a particular problem for economies such as the US and the UK which rely heavily on stock exchanges to price securities and help reallocate resources through take-over. This is deemed to be detrimental to long-term corporate development and overall economic growth. The paper seeks to show the extent to which directors of large UK companies perceive that analysts and institutional investors evaluate their companies on short-term criteria. The role of institutional investors in the context of short-termism is important because they own a large proportion of equity. The paper then seeks to explain why some company directors appear to believe in short-termism while others do not. Hence the paper is not investigating whether ‘the City’ is short-termist but is examining the reasons why directors of large publicly quoted companies believe ‘the City’ is or is not short-termist about their company. The conclusion of this paper is that there is some evidence to support the view that ‘the City’ is perceived as being short-termist towards some companies but that the phenomenon is more narrowly focused and of lesser importance than its supporters claim.     

Fiduciary duty or loyalty? Evidence from co-opted boards and corporate misconduct

We examine the effect of co-opted boards on corporate misconduct and document a significant positive relationship. Utilising a large sample of public U.S. companies from the period 2001 to 2015, we find that a one standard deviation increase in the proportion of co-opted directors on a board leads to a 4.3% rise in corporate misconduct. This outcome is robust to a series of sensitivity tests and continues to hold after accounting for potential endogeneity concerns. Further analyses indicate that co-opted directors propose fewer board agenda items, exhibit lower attendance at board meetings, and receive compensation packages in excess of industry norms, which exacerbate stakeholder-agency conflicts. Cross-sectional analysis demonstrates that the documented relationship is most pronounced among firms with weak external monitoring, greater CEO-board social ties, boards whose members have high career concerns, and where CEO power is low. Additional tests reveal that co-opted directors engage in more environmental- and workplace-related violations than other types of stakeholder violations. Overall, our investigation generates original evidence that the presence of co-opted directors aggravates the incidence of corporate wrongdoing. Our study contributes to the continuing debate on the role of boards of directors and has policy implications for those responsible for devising and monitoring effective systems of corporate governance.