For more than a year, many of America’s weightiest CEOs and investors have been working to solve a major issue looming over the companies and portfolios they oversee: There’s a gap in confidence between investors and the corporations that trade on public stock markets.
Many investors have grown frustrated with what they perceive as excessive executive compensation, bloated corporate structures and inattentive boards. CEOs, by contrast, often feel hamstrung by a myopic, tick-by-tick focus among investors on share prices. This disconnect has bred the rise of activist hedge fund investors, it’s forced corporate boardrooms to choose returns of capital over growth, and it’s caused many companies to exit public markets via mergers and buyout deals.
Finally, it seems America’s business leaders have come up with more than just platitudes to restore a longer-term vision to public markets, where investors can invest confidently again and business executives can refocus on their work launching new products, making capital investments, or expanding operations. On Thursday morning, a group of boldface investors and CEOs, including Warren Buffett, Jamie Dimon, Jeffrey Immelt,
General Motors
CEO Mary Barra, Larry Fink, head of Blackrock, and hedge fund activist Jeffrey Ubben of ValueAct Capital, co-signed a set of governance principles for companies and investors to live by. The document, detailed and tough-minded, may set a new standard in American corporate governance.
The recommendations from Buffett, Barra & Co. include common sense measures like diverse, experienced and well-trained corporate board members, and an urging of institutional investors to take take their votes as shareholders seriously. But included in the principles is a weighing in on how to rein in controversial corporate practices such as dual-class stock structures, heavy stock-based compensation, the increasing use of non-GAAP earnings metrics, and a reliance among investors on quarterly earnings guidance. How to deal with the creep of these practices may bridge an apparent deficit of trust on Wall Street.
In a detailed list of what it calls “Commonsense Principles of Corporate Governance” the group makes concrete recommendations on how boards are best constituted, a rubric for structuring executive compensation plans, and new guidance on how shareholders can become more engaged with their investments without putting a quarterly time clock on business plans.
Below are some highlights:
- Dual class voting is not a best practice. If a company has dual class voting, which sometimes is intended to protect the company from short-term behavior, the company should consider having specific sunset provisions based upon time or a triggering event, which eliminate dual class voting. In addition, all shareholders should be treated equally in any corporate transaction.
- Companies should consider paying a substantial portion (e.g., for some companies, as much as 50% or more) of compensation for senior management in the form of stock, performance stock units or similar equity-like instruments. The vesting or holding period for such equity compensation should be appropriate for the business to further senior management’s economic alignment with the long-term performance of the company. With properly designed performance hurdles, stock options may be one element of effective compensation plans, particularly for the CEO. All equity grants (whether stock or options) should be made at fair market value, or higher, at the time of the grant, with particular attention given to any dilutive effect of such grants on existing shareholders.
- Companies should frame their required quarterly reporting in the broader context of their articulated strategy and provide an outlook, as appropriate, for trends and metrics that reflect progress (or not) on long-term goals. A company should not feel obligated to provide earnings guidance – and should determine whether providing earnings guidance for the company’s shareholders does more harm than good. If a company does provide earnings guidance, the company should be realistic and avoid inflated projections. Making short-term decisions to beat guidance (or any performance benchmark) is likely to be value destructive in the long run.
- The principles set forth a number of commonsense recommendations and guidelines about the roles and responsibilities of boards, companies and shareholders. We firmly believe that empowered boards and shareholders, both providing meaningful oversight, are critical to the long-term success of public companies. But knowing that there is significant variability among the thousands of such companies and understanding that both context and circumstance matter, we have tried not to be overly prescriptive in how to achieve those goals. We also recognize that we live in a dynamic, fast-changing world – and that while many of these principles are and should be part of the corporate governance permanent landscape, some will inevitably change over time.
- Companies are required to report their results in accordance with Generally Accepted Accounting Principles (“GAAP”). While it is acceptable in certain instances to use non-GAAP measures to explain and clarify results for shareholders, such measures should be sensible and should not be used to obscure GAAP results. In this regard, it is important to note that all compensation, including equity compensation, is plainly a cost of doing business and should be reflected in any non-GAAP measurement of earnings in precisely the same manner it is reflected in GAAP earnings.
- Companies should consider paying a substantial portion (e.g., for some companies, as much as 50% or more) of compensation for senior management in the form of stock, performance stock units or similar equity-like instruments. The vesting or holding period for such equity compensation should be appropriate for the business to further senior management’s economic alignment with the long-term performance of the company. With properly designed performance hurdles, stock options may be one element of effective compensation plans, particularly for the CEO. All equity grants (whether stock or options) should be made at fair market value, or higher, at the time of the grant, with particular attention given to any dilutive effect of such grants on existing shareholders.
- Companies should maintain clawback policies for both cash and equity compensation.
- Asset managers should devote sufficient time and resources to evaluate matters presented for shareholder vote in the context of long-term value creation. Asset managers should actively engage, as appropriate, based on the issues, with the management and/or board of the company, both to convey the asset manager’s point of view and to understand the
company’s perspective. Asset managers should give due consideration to the company’s rationale for its positions, including its perspective on certain governance issues where the company might take a novel or unconventional approach.
- Given their importance to long-term investment success, proxy voting and corporate governance activities should receive appropriate senior-level oversight by the asset manager.
- Asset managers should consider sharing their issues and concerns (including, as appropriate, voting intentions and rationales therefor) with the company (especially where they oppose the board’s recommendations) in order to facilitate a robust dialogue if they believe that doing so is in the best interests of their clients.
“To ensure their continued strength – to maintain our global competitiveness and to provide opportunities for all Americans – we think it essential that our public companies take a long-term approach to the management and governance of their business (the sort of approach you’d take if you owned 100% of a company),” states the group, which also includes Verizon’s Lowell McAdam, Mary Erdoes of JPMorgan Asset Management, State Street’s Ronald O’Hanley, Brian Rogers of T. Rowe Price, Bill McNabb of Vanguard, Capital Group’s Tim Armour and Mark Machin, head of CPP Investment board.
“The principles set forth a number of commonsense recommendations and guidelines about the roles and responsibilities of boards, companies and shareholders. We firmly believe that empowered boards and shareholders, both providing meaningful oversight, are critical to the long-term success of public companies,” they add.
The stakes couldn’t be higher. Presently, more than 90 million Americans own our public companies through their investments in mutual funds, 401k plans, pensions and other retirement accounts.