Where governance fails
One example of lack of objectivity is the governance record of Walt Disney. For most of the 1990s, that company occupied a prominent place in BusinessWeek’s rankings of America’s worst corporate boards. While the company had a healthy balance sheet, straightforward accounting and an admirably diverse board, CEO Michael Eisner hand-picked most of the directors himself and installed some in roles for which they are ill-suited – a primary school principal and actor sitting on the compensation committee. Eisner also permitted, and in some instances promoted, conflicts of interest involving directors.
One co-chairman of the governance and nomination committee had a $50,000-a-year consulting contract with Disney and was chairman of a law firm that represented Disney. The other co-chairman had a daughter who worked for Disney’s consumer division, while another director on the governance panel had his wife on the board of Lifetime TV, which was 50 per cent owned by Disney. Such were the credentials of Disney’s board members. No wonder it was consistently rated to have the worst board and was consistently a target of shareholder activism.
Pressure to improve
Mounting pressure from shareholders, particularly institutional shareholders, was mainly responsible for many of the governance changes that have taken place in the US and UK. Companies that once ignored fair criticisms of their weak boards from disgruntled investors can no longer do so. Such was the case with Disney, whose shareholders demanded separation of the office of the chairman and the chief executive, solicitation of director nominees from major investors, set financial benchmarks and detailed succession plans. Under shareholder pressure, Eisner recruited governance guru Ira Millstein as adviser and commenced a series of changes.
After Enron, Disney was among the first companies to prohibit its external auditors from providing consulting services.
The company came clean about four directors whose family members had previously undisclosed Disney jobs and appointed independent directors to its audit and compensation committees. The independent directors hold meetings away from management and are restricted in the number of boards they can sit on. In addition, Disney bolstered the credibility of its financial reporting by using different firms for auditing and consulting. Despite the improvements to corporate governance, however, a no-confidence vote by shareholders and institutional investors stripped Eisner of the role as chairman, leading to his eventual resignation as chief executive a year later in 2005.
The changes in Disney typify the response of most poor corporate governance companies in the US to changes in regulation and oversight. These include introduction of the Sarbanes-Oxley Act, and changes to the requirements of the Securities and Exchange Commission, the New York Stock Exchange and Nasdaq’s listing standards. However, the changes taking place in these laggard companies appear to be driven less by the threat of government sanctions and intervention than by the stigma of being branded an unethical enterprise. Other companies recognise the importance of good governance to shareholders.
Performance and governance
One of the criteria investors use for selection is a company with good corporate governance practices. In the US, General Electric and Pfizer are examples of companies that have consistently been voted as having the best boards. Such companies are aware that having good corporate governance means enhanced shareholder value in the long run. This is consistent with the results of a study by Governance Metrics International (GMI), an independent governance rating company. The study showed that the shares of 26 companies that scored highest in their survey in 2004 for best governance practice outperformed the S&P 500 index by 10 per cent over five years. Analysis of the results by GMI also confirmed academic studies showing a correlation between share price performance and adherence to corporate governance best practice.
Could history repeat itself?
Despite all the regulatory reforms and the rush by companies to ensure compliance with various acts and codes on good corporate governance, there can be no assurances that there will not be any more scandals of the Enron kind. Many of the US companies that ran into trouble had all their corporate governance mechanisms in place, at least on paper. Enron’s board was a model board and it had truly independent board members. In 2002, the Enron Board was judged as one of the five best boards in the US by Chief Executive magazine. Yet it went kaput.
It appears that the presence of audit or compensation committees, codes of ethics and regulatory requirements are not failsafe. Ultimately, governance is dependent on the integrity of those in office, in control and in power. People who have integrity are invariably ethical. While the Sarbanes-Oxley Act is not an ethics warranty, integrity is. But the sad truth is, it cannot be legislated.
