December 23, 2008

Chris Cox: An Unusual “Admission”

Last Tuesday, the SEC issued this statement regarding the Bernie Madoff fraud. A number of folks have asked my opinion about the Chairman’s admission in this third paragraph:

Since Commissioners were first informed of the Madoff investigation last week, the Commission has met multiple times on an emergency basis to seek answers to the question of how Mr. Madoff’s vast scheme remained undetected by regulators and law enforcement for so long. Our initial findings have been deeply troubling. The Commission has learned that credible and specific allegations regarding Mr. Madoff’s financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action. I am gravely concerned by the apparent multiple failures over at least a decade to thoroughly investigate these allegations or at any point to seek formal authority to pursue them. Moreover, a consequence of the failure to seek a formal order of investigation from the Commission is that subpoena power was not used to obtain information, but rather the staff relied upon information voluntarily produced by Mr. Madoff and his firm.

While some read the Chairman’s remarks as candid and refreshing, I read them differently. I took them as not taking responsibility for the SEC’s failures. In seeming to throw the Staff under the bus – on his way out of the agency’s doors no less – the Chairman violates the “tone at the top” mantra as well as the one of “accountability” that the SEC is supposed to drum into our corporate leaders.

From the beginning, I didn’t like it that a sitting Congressman was appointed as the head of an independent agency. The SEC was already being “politicized” before Cox arrived, but this trend accelerated on his watch. And some say that Cox cared more about how the media perceived him than how the Staff performed (one of his responses to the credit crunch was hiring two more PR guys). It has been written that he fought budget increases for the SEC (albeit with some urging from Commissioner Atkins), even when those in Congress responsible for the SEC’s oversight urged him to seek more resources. Anyways, the SEC is in dire straights these days and a new Chair couldn’t come at a better time.

CEOs and Boards: “We Didn’t Do It”

Now, I’m certainly not blaming Chris Cox for this financial crisis (nor do I blame him for any failures in not catching Madoff – I just don’t like the manner of his admission). The government isn’t to blame for the greed that greased this wheel. What blows my mind is the “tone at the top” of our country’s leaders in the aftermath of this crisis. President Bush recently has said that he’s not to blame because all of the problems related to the crisis started before he got in office (somehow ignoring the fact that he is responsible to fix anything broken while he’s in office; plus ignoring his role as outlined in this NY Times article). More importantly, the CEOs and boards of this country have shown no remorse for the pain that “Main Street” is now feeling due to their missteps.

This Washington Post article about General Motor’s recent apology describes the cultural difference between corporate leaders in this country compared to others like Japan. In Japan, CEOs would be publicly apologetic if they were on the job during a time like this, offering up their resignations. In our country, there is no humilty, no true leadership. Rather, there is a rush to revise compensation arrangements to take advantage of a down market to reprice, etc.

Holding CEOs Accountable: Boards Last to See What’s Wrong

In a WSJ editorial last week, Yale Professor Jonathan Macey wrote these interesting words to describe what has happened here:

The failure of the General Motors board of directors to fire CEO Richard Wagoner provides a rare glimpse into the inner-workings of big-time corporate boards of directors. The sight is not pretty.

When Mr. Wagoner took the helm eight years ago the stock was trading at around $60 per share. The stock had fallen to around $11 per share before the current financial crisis. It’s now below $5 per share.

In 2007, Mr. Wagoner’s compensation rose 64% to almost $16 million in a year when the company lost billions. The board has been a staunch backer of Mr. Wagoner despite consistent erosion of market share and losses of $10.4 billion in 2005 and $2 billion in 2006. In 2007 GM posted a loss of $68.45 a share, or $38.7 billion — the biggest ever for any auto maker anywhere.

The GM board is now reportedly meeting several times a week. But beneath the appearance of activity, nothing is happening at GM other than the company’s poorly articulated pleas for a government bailout and threats of dire consequences if GM is not bailed out.

When Connecticut’s Sen. Chris Dodd mentioned that Mr. Wagoner might have to go, GM spokesman Steve Harris was quick to defend him: “GM employees, dealers, suppliers and the GM board of directors feel strongly that Rick is the right guy to lead GM through this incredibly difficult and challenging time.”

The average pay for chief executives of large public companies in the United States is now well over $10 million a year. Top corporate executives in the United States get about three times more than their counterparts in Japan and more than twice as much as their counterparts in Western Europe. In my new book “Corporate Governance: Promises Made, Promises Broken,” I argue that executive compensation is too high in the U.S. because the process by which executive compensation is determined has been corrupted by acquiescent, pandering and otherwise “captured” boards of directors.

Like parents unable to view their children objectively, boards reject statistical reality and almost always view their firms as above average. Because directors participate in corporate decision-making, they inevitably take ownership of the strategies that the corporation pursues. In doing so, directors become incapable of evaluating management and strategies in a detached manner.

As board tenure lengthens, it becomes increasingly less likely that boards will remain independent of the managers they are charged with monitoring. The capture problem is exacerbated by the incentives of managers to develop close personal ties with directors. Mr. Wagoner has had 10 years to cultivate his board. Of the 13 “independent” directors on the board, eight of them have served with Mr. Wagoner since 2003.

Once an opinion, such as the opinion that a CEO is doing a good job, becomes ingrained in the minds of a board of directors, the possibility of altering those beliefs decreases substantially. All too often, it is only when an outsider takes an objective look does anybody realize the obvious: That the directors of a company are generally the last people to recognize management failure.

We need to encourage market solutions — not bureaucratic ones — as the best strategy for addressing the corporate governance failures we face today. Hedge funds and activist investors like Carl Icahn are the solution, not the problem. The market for corporate control should be deregulated and the SEC’s restrictions on all sorts of equity trading should be lifted at once.

Little if anything has changed at GM since dissident director H. Ross Perot dubbed his board colleagues “pet rocks” for their blind support of then CEO Roger Smith. The broader problem is that there are far too many pet rocks on the boards of other U.S. companies.

– Broc Romanek