Study Finds Incentive Compensation May Spur Pension Conversions
Submitted by: Rosanna Weaver, Governance Research Services Analyst
A recent working paper, "Why Do Firms Convert to Cash Balance Pension Plans? An Empirical Investigation," written by Julie D'Souza of Cornell University, John Jacob of the University of Colorado, and Barbara Lougee of Morgan Stanley found the timing of "cash balance" conversions "appears to be linked to incentive compensation and profitability." Critics of these pension fund changes have suggested that companies may be motivated by the desire to inflate their book profits with surpluses in their pension trust funds, which are freed up by the conversion.
It's important to note defined benefit plans reward employees for long service while cash-balance plans tend to treat all workers equally. A typical traditional plan accrues benefits based on a percentage factor, multiplied by the number of years of service, multiplied by the participant's final five-year average base pay. Cash balance plans instead annually reserve a fixed percentage of base salary, plus interest, and are portable.
The study also found those who made the conversions do not have greater employee turnover than firms that retained their traditional defined benefit-plans, a fact that countered the argument the changes were made for the benefit of a more mobile work force. Additionally, the conversions were more common when incentive compensation was a larger proportion of total compensation.
In 1999, when International Business Machines (IBM) shareholders converted its traditional defined benefit pension plan into a cash-balance, defined contribution plan, angry employees took the issue directly to the shareholders with a proposal that was subsequently filed at other firms.
The next year when over 300 IBM shareholders first co-filed the proposal, which sought to allow employees the choice between defined benefit pension plans and defined contribution pension plans, it faced a strong challenge at the SEC. The company attempted to exclude the proposal on the grounds that it dealt with a topic, which was part of the company's ordinary business.
The SEC ruled the public attention focused on the pension plan conversion means the matter no longer qualifies as ordinary business. In its decision to refuse the no-action request, SEC Special Counsel Carolyn Sherman said, "In view of the widespread public debate concerning the conversion from traditional defined benefit pension plans to cash-balance plans and the increasing recognition that this issue raises significant social and corporate policy issues, it is our view that proposals relating to the conversion from traditional defined pension plans to cash-balance plans cannot be considered matters relating to a registrant's ordinary business operations." The proposal won the support of 28.2 percent of the votes cast in that year. Though it was later filed at a range of companies, including Boeing and AT&T, it never received significantly higher support.
Opponents of conversions appear to have largely given up using the shareholder proposal venue as a way to publicize their concerns, but this study indicates that some of the concerns they raised years ago may have been on target.
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August 28, 2006 |
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U.S. Management-Led Buyouts On The Rise
Submitted by: Chris Young, Director of M&A Research
An interesting piece by Caroline Humer ran on the Reuters wire a few days ago titled U.S. Management-Led Buyouts Soar. What's most astounding is her statistic on U.S. management buyouts.
"So far this year, $74.7 billion has been announced in U.S. management buyouts compared with $9.2 billion last year, accounting for more than 9 percent of U.S. merger and acquisition deals, up from 1.2 percent in the year earlier period. That growth also outpaces the growth in U.S. private equity and M&A overall, up151 percent and 25 percent respectively this year."
Leveraged buyouts account for a significant percentage of today's M&A activity. Some of the LBO bidding groups include current management or significant individual shareholders like company founders. For target shareholders, LBOs (and in particular MBOs), create unique factors to consider when weighing whether to vote for or against a proposed deal.
One issue that has been causing investor consternation is the shortened payout period between buyout and monetization event. Historically, private equity buyers put in three to five years of hard work before selling the company or taking it public again. Recently, however, financial sponsors have sometimes paid themselves special dividends within months that allow them to continue to own the portfolio company using "house money." In such cases, shareholders wonder why the company couldn't remain public and allow the value to flow to public shareholders.
MBOs add an additional concern: that insiders who know the company best are somehow taking advantage of that knowledge to buy the company on the cheap. Again, shareholders wonder why incumbent management cannot do for them what it plans to do for the financial sponsors.
What are your thoughts on management-led buyouts? We welcome your comments.
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August 24, 2006 |
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Insurance Companies and Climate Change
Submitted by: Doug Cogan, Deputy Director of ISS' Social Issues Service
One year ago today, Hurricane Katrina formed in the Atlantic Ocean. Within a week, it became the nation's worst natural disaster, causing $45 billion in insured property losses. Since Katrina and the record number of hurricanes that followed, the insurance industry has raised rates and pulled back coverage along the East and Gulf Coasts. But is this a sustainable strategy? A new CERES Report released on Tuesday estimates that the insurance industry has turned down $3 billion in premium renewals rather than face the risk of added losses.
Making matters worse, global warming is implicated in spawning not only more intense hurricanes like Katrina, but also in exacerbating a range of other weather-related disasters, including drought, wildfire, floods and life-threatening heat waves -- all of which have hit portions of the country this summer. Instead of remaining passive in the face of rising damage claims, the insurance industry is becoming more proactive. The Ceres report highlights dozens of ways that the industry is starting to address global warming by encouraging actions that cut down on greenhouse gas emissions. These range from reducing insurance premiums for "green buildings" and people who drive their cars less to providing insurance for new alternative energy and energy-saving projects.
The takeaway point of the study -- and a Fortune article written yesterday by Mark Gunther -- is that addressing global warming can be smart and profitable for companies that are looking ahead, while those who ignore the problem are as vulnerable as those who think they can ride out a storm like Katrina.
Do you believe the insurance industry is doing an effective job managing climate change? We welcome your thoughts.
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August 23, 2006 |
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Securities Class Action Rumblings in Europe
Submitted by: Bruce Carton, Vice President of Securities Class Action Services
This article (subscription req'd) entitled "Head of the Class" in the August 18, 2006 issue of TheDeal.com suggests that the long-standing aversion to securities class actions in Europe may soon become a thing of the past. According to the article,
"Within the past year, several European Union countries have either enacted laws or considered legislation that would pave the way for class actions. Last summer, a new Dutch law authorized associations representing injured parties to collectively negotiate settlements; in July, a group of French investors followed up with a class action in a Dutch court. The target: Airbus parent European Aeronautic Defence and Space Co., or EADS, whose stock recently collapsed. In the past 12 months, Germany and Spain began to permit collective shareholder action under certain circumstances. In July, the center-left government of Italian Prime Minister Romano Prodi passed a decree explicitly authorizing class actions; if parliament does not approve the law by September, it will expire. France's center-right government is considering a similar statute."
The article states that this possible "change of heart" in Europe may be the product of a recent spate of scandals that have harmed European investors, including "the December 2003 insolvency of [Italian] dairy company Parmalat Finanziaria SpA, which collapsed with some 14 billion Euros ($18 billion) in debt, and the 2002 demise of canned food maker Cirio SpA, which defaulted with more than 1 billion Euros in outstanding obligations. More than 100,000 Italian investors held Cirio and Parmalat bonds."
These and many other international developments in securities class actions were the subject of a February 2006 ISS Corporate Governance Forum webcast entitled "Securities Class Action Litigation Moves Beyond US Borders," which featured attorneys representing eight countries. An archived version of that webcast is available here.
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August 22, 2006 |
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AFL-CIO Questions Firms Over Post-Sept. 11 Option Grants
Submitted by: Ted Allen, Director of Publications
The AFL-CIO has asked UnitedHealth Group, Merrill Lynch, and four other companies to explain why their executives were granted stock options after the Sept. 11, 2001, terrorist attacks, when U.S. markets declined.
The labor federation said it wrote to the firms' compensation committee chairs seeking an explanation for the grants by the companies, which didn't normally grant options in September. The AFL-CIO also sent letters to: Sandisk, Stryker, Teradyne, and Apollo Group. The six issuers were mentioned in a July article in The Wall Street Journal about 91 companies that made unusual grants in the first two weeks of trading after the Sept. 11 attacks, the labor federation said.
In his Aug. 9 letter to UnitedHealth, the labor federation's secretary treasurer, Richard Trumka, wrote: "The timing of stock option grants during the post-9/11 period of depressed stock prices raises the issue of whether executives took advantage of a national tragedy to compensate themselves . . . Lastly, any unusual timing of post 9/11 stock option grants could be an indication that they were inappropriately backdated."
At UnitedHealth, the directors are also under scrutiny for the equity compensation they received. On Aug. 10, Bloomberg News reported that the health insurer's 10 non-executive directors held $230 million in stock as of late March, when the company filed its proxy statement. Those directors also held more than 3.1 million stock options with an underlying value of $175 million.
"You have to ask yourself, are these people paying attention to the mission of the corporation, or are they being distracted by the amount they're getting themselves?" Minnesota Attorney General Mike Hatch told Bloomberg News.
Overall, more than 108 companies have disclosed internal or regulatory probes into their stock option practices. Among the latest firms to announce internal probes are Keithley Instruments, an Ohio company that makes testing equipment for semiconductors, and BEA Systems, a California software firm.
In the past two weeks, PMC Sierra, a maker of semiconductors; J2 Global Communications, which makes communications software; electronics manufacturer Sanmina-SCI; and Boston Communications have delayed filing their quarterly financial results. With late filings, some firms have fallen out of compliance with Nasdaq Stock Market listing requirements. After receiving delisting notices this week, Apple Computer, Juniper Networks, Rambus, Qwest Software, and Monster Worldwide said they would seek hearings before Nasdaq's listing panel. Rambus, a computer chip designer, also announced that ex-CEO Geoff Tate, who had served as the sole member of the company's stock option committee, had resigned from the company's board.
In addition, software maker McAfee said it would restate three years of earnings, while Amkor Technology, a packager of semiconductors, said it would restate more than eight years of results, according to news reports. Earlier, 14 executive officers at Molex, an Illinois-based supplier of electronic connectors, agreed to reimburse the company $685,000 for gains they received from misdated stock options, according to ElectronicsWeekly.com.
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August 21, 2006 |
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Agency Seeks Comment on "Couric" Pay Rule
Submitted by: Subodh Mishra, Staff Writer
The Securities and Exchange Commission last week released much-anticipated new rules governing the disclosure of boardroom pay. The rules, adopted late last month, mark the first time in 14 years that the commission has addressed executive and director pay disclosure.
While the 436-page set of final rules will take effect 60 days after its publication in the Federal Register, the commission opted to solicit further public comment on the so-called "Katie Couric" provision that calls on firms to disclose the pay of three of the highest-paid non-executive employees. (That moniker refers to Couric, a television newscaster who recently signed a multi-million dollar deal with CBS.)
The rule, proposed in January, was criticized by Wall Street firms and media companies, which voiced concerns over competitors' potential ability to poach talent, and the likelihood that internal rivalries would develop if employees were privy to their colleagues' pay. The SEC revised the rule last month carving out employees with no responsibility for significant policy decisions--such as star athletes and entertainers--while indicating the rule would only apply to large capital companies. Employees' names also would not be disclosed, the SEC said.
The SEC is seeking comment on whether the re-proposed rule balances investors' needs for compensation information with the privacy concerns of non-executives. The commission also is seeking input on whether it should require companies to describe the duties of the three top-paid non-executives and define the phrase "responsibility for significant policy decisions," according to Bloomberg News. Comments must be submitted within 45 days of publication of the proposed rule in the Federal Register.
For more on the pay rules, please visit the SEC's website.
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August 18, 2006 |
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Introducing the ISS 2006 Proxy Season Review
Submitted by: Sarah Cohn, Director of Communications
Most of the 2006 proxy season vote results are in. Highlights from ISS' 2006 Proxy Season Scorecard to-date include:
--Majority vote to elect director proposals received an average level of support of 47.8 percent, up from 43.7 percent in 2005.
--Use performance-based vesting proposals received an average level of support of 41.5 percent, jumping more than nine percentage points from 2005.
--Disclose political contribution proposals received an average level of support of 20.7 percent, which is more than double last year's average.
Stay tuned for further updates.
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August 17, 2006 |
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Options Backdating Securities Class Actions: The List-Update
Submitted by: Bruce Carton, Vice President, Securities Class Actions
Our options backdating securities class action list has been updated to add Witness Systems, Inc. The number of companies on the list now stands at 13.
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August 16, 2006 |
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Settlement Fever
Submitted by: Chris Young, Director of M&A Research
Despite what readers might anticipate in light of the extensive media coverage of proxy fight votes, more contests settle than actually go to a vote. So far in 2006, 31 of 51 selected fights (61%) culminated in a settlement, thereby avoiding a harsh "winner vs. loser" epitaph.
Settlements between issuers and activist shareholders are typical of the (sometimes last minute) compromise a target company will "choose" when it becomes clear that it will lose a proxy fight. With a settlement, the issuer may be able to extract some concessions from the dissidents (usually a board seat or two) that it was unlikely to have obtained if the original slates had gone to a vote. Moreover, the company is able to save face by not officially "losing" the contest (at least for posterity). In contrast, the dissidents often are able to get everything they asked for and appear reasonable in the bargain, which can only enhance their options in future proxy fight negotiations.
The fact that some companies wait until the eleventh hour to settle indicates: (i) some proxy fights are difficult to handicap, and/or (ii) some companies have a misguided sense of the level of support they will receive from the shareholder base. In many cases, it may be a wiser course to settle with the dissidents at an earlier stage in order to avoid the costly distraction of a fight that is very much in the public eye. Many of the companies who have opted to settle this year have chosen such a course, thereby avoiding the embarrassment of a meeting day loss.
We welcome your thoughts on this year's settlement fever.
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August 15, 2006 |
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Takeover Attempt May Set Precedent on Pill Adoptions
Submitted by: Valentina Judge, Research Analyst
A controversial takeover battle between two of Japan's largest paper manufacturers may prompt a legal ruling on how and when Japanese companies can deploy poison pill defenses.
The use of pills has grown exponentially in Japan over the past 18 months, but the legality of their use in some circumstances remains questionable, leaving both issuers and shareholders searching for guidance from Japan's judiciary.
A recent takeover attempt pitting bidder Oji Paper against rival Hokuetsu Paper Mills has invited judicial scrutiny because of the target's adoption of a pill without shareholder approval and subsequent issue of warrants to a "white knight" investor, legal experts say.
The pill, which would remain in effect until the next annual shareholder meeting when it would be put to a shareholder vote, is relatively standard for Japan. The terms include a 20 percent trigger, the establishment of an independent but non-board level committee (composed of three non-executive statutory auditors) to review the terms of any takeover offer and present a non-binding recommendation on whether to deploy the pill, and a commitment to reduce board terms to one year.
Currently, Hokuetsu's board has no outsiders (nor does Oji's), and the terms of the pill do not obligate the board of directors to accept the committee's recommendation, should the committee favor the takeover offer and thus recommend against deploying the pill. Hokuetsu's independent committee on Aug. 8 recommended to the board that the pill be deployed.
The committee's independence is one issue the courts will focus on, experts say. The role of the [independent committee] is "to fairly and impartially determine whether the takeover bid will increase the value of the target company," notes Waseda University's Tatsuo Uemura in comments made to the Nihon Keizai Shimbun.
Without shareholder approval of the pill, however, Hokuetsu runs the risk of skeptical judicial scrutiny. According to ISS data, at least 60 other Japanese companies have adopted pills without shareholder approval this year, but few have done so in the face of a takeover bid.
A precedent-setting decision last year by the Tokyo District Court, upheld by the Supreme Court, forced process control equipment maker Nireco to withdraw a poison pill passed by the board of directors without shareholder approval.
A Ministry of Economy Trade and Industry and Ministry of Justice white paper published in May 2005 appeared to endorse so-called advance warning takeover defenses. However, while prescribing pill-like defense mechanisms, the paper warned that regulations should not permit poison pills to be used simply to hold off a hostile bid or to entrench management.
Moreover, shareholder opposition of poison pills and other takeover-related defenses is on the rise. Influential pension fund associations have adopted more stringent proxy voting policies against such proposals, including the Pension Fund Association's policy of voting against directors of companies adopting poison pills that are "structured such that the deployment is left to the discretion of the board of directors," according to a June 29 Nihon Keizai Shimbun article.
A recent survey by the Japan Securities Investment Advisers Association indicated that 50 percent of respondents either voted against or abstained on management proposals, an increase of 11 percent over the previous year. Those proposals typically resulting in a negative vote or abstentions were executive retirement bonus plans and anti-takeover proposals, the Nihon Keizai Shimbun reported.
Hokuetsu's white knight tactic may compound the risk of a negative judicial ruling. Two days after announcing its implementation of the pill, Hokuetsu's board entered into an alliance with Mitsubishi Corp. that included the issuance of shares at a discount to the market price, allowing Mitsubishi to acquire up to a 24 percent stake in Hokuetsu.
One issue being debated in legal circles is disclosure. The Knight Ridder wire service reported that the Tokyo Stock Exchange (TSE) was considering disciplinary action against Hokuetsu for its failure to disclose Oji's bid when discussing with the TSE its intent to adopt a poison pill ahead of the public announcement. The company also failed to disclose Oji's offer to the market, as it worked out the deal with Mitsubishi.
In the face of a white knight defense, Oji could seek injunctive relief from the courts, although it has not yet made a move in that direction. Last year, Internet marketer Livedoor's attempted takeover of Nippon Television led the target's cross-shareholding partner, Fuji Television, to issue a flood of warrants to dilute Livedoor's stake. The court issued an injunction to block the issue of the warrants.
Should a deal go through, the combination of Oji and Hokuetsu would form the world's fifth-largest paper company.
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August 11, 2006 |
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Heinz Fight Enters Final Round
Submitted by: Ted Allen, Director of Publications
H.J. Heinz Co. management has won the endorsement of three labor investors and the California Public Employees' Retirement System in its high-profile proxy fight with billionaire investor Nelson Peltz. Most other institutional investors have not yet announced how they will vote, leaving it still unclear who will prevail.
Peltz and his Trian Group hedge fund, which have a 5.5 percent stake in the company, have put forth five nominees for Heinz's 12-member board. The company's annual meeting will be Aug. 16 in Pittsburgh.
ISS has advised investors to back Peltz and two other dissident nominees. A second advisory firm endorsed Peltz and one Trian nominee, while a third firm urged shareholders to vote for Peltz. (For more details on the ISS vote recommendation, see the last section of this article.)
Trian, which has faulted Heinz's financial performance under CEO William Johnson, has called on the maker of ketchup and other food products to sell assets and make $575 million in spending cuts. In response, Heinz has moved to make $355 million in cuts, cut 2,700 jobs, and undertake a $1 billion share buyback. The company also has adopted governance reforms, including majority voting for director elections, and hired a search firm to recruit two more independent directors.
On Aug. 10, Heinz announced that CalPERS, the nation's largest public pension fund, would suppport management. The day before, the Amalgamated Bank's LongView Collective Investment Fund said it would back the incumbent nominees. Earlier, the AFL-CIO endorsed the management slate and identified the Heinz contest as the first of its "key votes" for the 2006-07 proxy season. According to the labor federation, "the Trian nominees failed to demonstrate that they are better qualified to build shareholder value." The CtW Investment Group, which is affiliated with the Change to Win union coalition, also has endorsed management.
Most of Heinz's other institutional investors have not disclosed which side they will support. Trian likely will have support from other hedge funds, which traditionally support dissidents in proxy fights.
With less than a week before the annual meeting, Trian and Heinz have issued dueling press releases on voting mechanics. Trian urged investors to vote its "gold" proxy card, even if they don't plan to support all five dissident nominees. Heinz has called on shareholders to use the company's "white" proxy card to support all 12 management nominees. Heinz argues that investors who use the dissidents' proxy card to vote for any Trian nominees will not be able to cast write-in votes to support any of the five management nominees targeted by the dissidents. However, Trian points out that investors who try to write in the names of any dissident nominees on management's proxy card could have their votes deemed invalid.
Peltz, who describes himself as an "operational" activist, has had success in seeking board representation in the past. In March, he persuaded Wendy's International to install three of his board nominees after calling on the hamburger chain to improve its results and consider selling its Baja Fresh restaurants. In making his case to Heinz investors, Peltz has pointed to his experience at other companies, such as beverage maker Snapple, which he bought for $300 million in 1997 and sold for $1.5 billion four years later.
"We've spoken to all major shareholders, and we've gotten a very positive reception," Peltz told the Reuters news service.
Politicians Express Concern
The contentious proxy contest has also attracted the interest of Pennsylvania politicians. On July 19, eight members of Congress from the state wrote to Pennsylvania Attorney General Thomas Corbett, expressing concern about "the potential harm to shareholders, employees, and communities"' from Trian's bid for board representation, according to the Associated Press. The mayor of Pittsburgh and two state lawmakers also wrote to Corbett, warning that Peltz's growth strategy may lead the company to move from Pittsburgh, its headquarters for 137 years. A Trian spokeswoman said the dissidents, if elected, would not recommend that the company leave Pittsburgh, AP reported.
Pennsylvania officials have a long history of intervening in corporate disputes. The state has one of the most extensive arrays of anti-takeover statutes. In 1990, Pennsylvania adopted control-share acquisition provisions as Armstrong World Industries tried to defeat a bid by Canada's Belzberg family. In 2002, then-Attorney General Mike Fischer sued to block an auction of Hershey Foods by the charitable trust that owns the company. Fischer argued that job and tax revenue losses from a sale could devastate the Pennsylvania community where the company is based.
Earlier this year, state lawmakers rushed to approve legislation to help Sovereign Bancorp fend off a bid by Relational Investors to remove Sovereign's CEO, despite complaints from investor advocates that the law would hurt shareholder rights. Sovereign and Relational reached a settlement in March.
ISS Backs Three Trian Nominees
In the Heinz proxy fight, ISS has advised investors to support Peltz and two other Trian nominees, golfer and entrepreneur Greg Norman, and former Snapple executive Michael Weinstein. The vote recommendation was based on the ISS benchmark governance policies.
In its recommendation, ISS noted that the dissidents would bring consumer marketing expertise to the board and would help keep the pressure on management. "In speaking with industry analysts and long-term shareholders, we were told that the company has a long history of over-promising and under-delivering. Shareholders expressed fatigue from year after year of meetings in which management promised things would be better soon. The company claims that those days are over, but we believe that the presence on the board of three of the dissidents' nominees would keep management's feet to the fire," the ISS recommendation noted. "On balance, we conclude that the presence of three of the dissidents on the Heinz board would likely prove beneficial to long-term shareholder value. The long-term financial and operational performance of the company and the dissidents' skill sets and track record establish both the need for change and the dissidents' ability to effect change."
Meanwhile, the ISS Taft-Hartley Advisory Services unit, which advises labor unions and their fund managers, has endorsed the full management slate. That vote recommendation was based on the AFL-CIO's voting guidelines and input from labor union clients.
In addition to its benchmark and Taft-Hartley policies, ISS offers a broad selection of voting guidelines, including an environmental and social policy, a public fund policy, a faith-based policy, and a variety of policies that reflect local market practices across the world. ISS' Governance Research Service also provides non-recommendation research. This range of offerings allows institutions to subscribe directly to the policies that reflect their own corporate governance philosophies or those of their underlying clients.
For more on the arguments by Heinz, please visit here.
For more argurments by Trian, please visit here.
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August 10, 2006 |
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Comverse Execs Face Criminal Charges
Submitted by: Bruce Carton, Vice President, Securities Class Action Services
The Criminal Complaint filed today by federal prosecutors against three former executives of Comverse Technology (the former CEO, CFO and General Counsel) for options backdating is available here, courtesy of the WSJ Law Blog.
Before your eyes glaze over and you hit the "Back" key to go read about something less arcane than strike dates, compensation accounting rules, etc., just know that the stuff in the Criminal Complaint is pretty fascinating. The FBI agent providing the statement in the Criminal Complaint gets deep into the details of the alleged scheme at Comverse, including the creation of a secret slush fund account called Phantom in which options to fictitious employees were stashed and later awarded to favored employees for recruitment and retention.
The Criminal Complaint also details the alleged cover-up of the scheme when the WSJ started asking questions about options grants in March 2006, which according to the complaint included evidence tampering and numerous misstatements and half-truths to company lawyers, the company's auditors, the WSJ, and the Special Committee hired to investigate the matter.
One of the more interesting statements in the Criminal Complaint is that according to the defendants, the backdating practice was shut down in April 2002 because of "the advent of Sarbanes-Oxley and a more stringent enforcement 'environment.'"
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August 9, 2006 |
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Changing Governance of Australia's Banks
Submitted by: Stephen Chu, Senior Research Analyst, Australia
The boards of Australian banks have become smaller and more independent since the 1980s, while increases in executive pay have far outpaced the banks' performance, according to a recent ISS analysis.
This analysis of governance trends at banks listed on the Australian Stock Exchange (ASX) includes various indicators, such as: the number of directors; board composition and committees; and executive remuneration levels in the 1980s, 1995 and 2005.
Since the 1980s, bank boards on average have become smaller. In the 1980s, Westpac Banking and Australian and New Zealand Banking had the largest boards each with 15 directors.
This changed little in 1995, with the largest board having 14 directors.. However, between 1995 and 2005 there was a marked decrease in board size, with all but three banks in the sample decreasing their directors to below 10. Two banks, Commonwealth Bank of Australia and Suncorp-Metway had 10 directors and National Australia Bank had 14.
Drawing on academic research such as David Yermack's 1996 Higher Valuation of Companies with a Small Board of Directors, evidence suggests a correlation between smaller boards and better company performance. That holds true in this case, with the worst performing bank in terms of earnings per share growth between 1995 and 2005--National Australia Bank--also having the largest board during that period.
Conversely, Westpac during its disastrous period in the early 1990s when it recorded a massive loss of A$1.6 billion ($1.2 billion) due to bad debts in Australia's property markets, cut its board size by almost one-third.
While the reasons for the reduction in bank board size are unclear, the data does support the notion that smaller board companies tend to outperform larger board firms--the smaller banks with around seven or eight directors generally performed better than the larger board banks.
Indeed, earnings per share growth between the 1980s and 1995 for smaller banks such as Bendigo Bank (12.2 percent), Adelaide Bank (177 percent), Suncorp-Metway (120.2 percent), Bank of Queensland (60.0 percent) and St. George Bank (57.9 percent) had all outperformed the limited earnings per share growth information for large capital banks including Australia and New Zealand (minus 10.8 percent) and Westpac (minus 11.6 percent).
The study also found that bank boards became more independent throughout the sample period, with all boards increasing independence levels by at least 50 percent by 2005. In the 1980s, many banks had a substantial number of shareholder-nominated directors on their boards, with the highest being Bank of Queensland with five affiliated directors representing its dominant shareholder. By 2005, however, none of the studied banks had directors representing a dominant shareholder.
This particular change reflects in part the transformation of small building societies--local and regional Australian financial institutions that are somewhat akin to U.S. credit unions--into large publicly listed deposit-taking institutions. Examples of this include the Co-operative Building Society of South Australia's conversion into Adelaide Bank, St George's Co-operative Building Society change into St. George Bank, and the Bendigo Building Society's transformation into Bendigo Bank
Meanwhile, compensation for bank executives has increased exponentially since the 1980s. The highest paid executive in the 1980s was Bob Joss at Westpac, who received approximately A$1.94 million ($1.48 milion) in annual compensation. In 2005, this amount increased to A$7.5 million ($5.7 million) for current Westpac CEO David Morgan. Overall, CEO pay grew at the banks studied grew between 90.1 percent and 392.6 percent from the 1980s to 1995. From 1995 to 2005, pay increases between 78 percent and 721 percent were evidenced, with the highest at Suncorp-Metway.
The rise outstripped the increase in the consumer price index over the same period, with CPI growing by only 53.7 percent between 1980s and 1995, and 27.7 percent between 1995 and 2005. The pay increases also outpaced increases in profitability. From the 1980s to 1995, basic earnings per share grew 62.1 percent at National Australia Bank, while CEO pay soared 392.6 percent. At Westpac, CEO pay increased 234.5 percent, while there was an 11.6 percent decrease in earnings per share growth.
The trend from 1995 to 2005 was similar, with National Australia Bank again increasing its CEO's remuneration by 344.8 percent, but the bank was able to simultaneously drive earnings per share growth by just 78.7 percent. The closest link of the two variables is evident at Adelaide Bank, where modest increases in CEO remuneration of 167.5 percent and 78 percent from the 1980s to 1995 and 1995 to 2005, respectively, were accompanied with increases in earnings per share of 167.5 percent and 110.1 percent over the same periods.
The marked rise in pay--particularly over the most recent period studied--can in part be attributed to the mandatory disclosure of option values beginning in 2002, which served to inflate 2005 figures. Moreover, the use of options as a component of pay was nowhere near as prevalent in the 1980s in Australia as it is today. It is noteworthy that the two longest-serving bank CEOs in the survey--Robert Hunt of Bendigo Bank and Barry Fitzpatrick of Adelaide Bank--received the lowest total remuneration, although both banks are small relative to others in the survey.
Executive pay increases in the Australian banking industry in the past 20 years has attracted considerable attention from shareholders and others, and analysts predict it may only be a matter of time before boards find it increasingly difficult to justify such rewards.
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August 7, 2006 |
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Regulators Seek Greater Scrutiny of Options
Submitted by: Ted Allen, Director of Publications
The Public Company Accounting Oversight Board (PCAOB), which oversees U.S. accounting firms, has called on auditors to pay closer attention to whether companies have properly accounted for the cost of stock options.
The PCAOB, in a July 28 alert, said accounting firms should ask companies that use options as a major component in executive pay or have high stock volatility to provide letters certifying that their stock options have been properly accounted for. The agency also urged auditors to review past financial statements if questions over past option grants arise, according to news reports.
"We're pleased to see that the PCAOB has released the guidance, and that it makes clear that the public company auditors have a responsibility under the auditing standards to conduct a wide-ranging inquiry into options abuses,'" Damon Silvers, associate general counsel at the AFL-CIO, told Bloomberg News.
More than 80 companies are under investigation by the Securities and Exchange Commission into whether option grant dates were backdated or otherwise manipulated to maximize executive compensation.
For more coverage on options timing, go to the ISS Options Backdating Information Center.
Also on July 28, Mark Everson, commissioner of the Internal Revenue Service, directed the agency's audit staff to work with the SEC to scrutinize companies to see if they owe taxes for improper option grants. Everson said the IRS would look at 30 to 40 companies.
"In light of recent troubling reports of misconduct in connection with the backdating of stock options, the IRS will examine relevant cases to determine that both the companies and executives involved satisfied their tax obligations,'" Everson said in a statement.
Meanwhile, more companies have disclosed reviews of their option grants. On Aug. 3, Florida-based Pediatrix Medical Group delayed reporting its full quarterly results and said its audit committee is reviewing past option grants. A day earlier, Ceradyne, a California firm that makes body armor, said a board committee would review option grants from 1997 to the present. Activision, a maker of video games, said July 28 that the SEC had begun an inquiry into the California-based company's option grants.
On July 31, CA Inc., the world's No. 2 seller of software for mainframe computers, reported that many options were improperly priced before 2002, resulting in an additional expense of $342 million. On Aug. 3, Clorox, a California company that sells bleach and other household products, reported that errors in accounting for past option grants had resulted in a $16 million expense.
Mercury Interactive, where three top executives quit last November after an options probe, announced Aug. 1 that former CEO Ammon Landan reached a legal settlement and agreed to give up options to buy 437,500 shares that he was granted in January 2003, according to the Silicon Valley/San Jose Business Journal. The company previously voided 2.6 million of Landan's options. Mercury has restated its results from 2003, 2004, and 2005, and reported $566.7 million less income. Mercury said it expects to spend $70 million in legal expenses as it deals with past option grants.
Earlier, Moody's Investor Service said it would consider downgrading the credit ratings of firms that are under scrutiny for their option grants. Moody's has already lowered its ratings on bonds issued by CA, Jabil Circuit, Newpark Resources, and UnitedHealth Group.
"Companies that have stock option problems also are likely to have other corporate governance problems," Jeffrey Benner, an analyst at Moody's, told Bloomberg News.
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August 2, 2006 |
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Paulson Hints that the Sarbanes-Oxley Act May Have Gone Too Far
Submitted by: Sarah Cohn, Director of Communications
There is an interesting article today on CFO.com titled "Paulson: Regs Went Too Far" by Stephen Taub. The piece reports that Hank Paulson, in his first speech as Treasury Secretary, hinted at trimming back SOX, suggesting that "often the pendulum swings too far and we need to go through a period of readjustment."
What are your thoughts on SOX reform? We welcome your comments.
CFO.com
Paulson: Regs Went Too Far
In his first speech as Treasury Secretary, Hank Paulson hints at trimming back Sarbox, suggesting that it's time to "achieve the right regulatory balance."
Stephen Taub, CFO.com
August 01, 2006
Treasury secretary Henry Paulson is the latest among a growing number of government and corporate leaders to suggest that the Sarbanes-Oxley Act and other regulatory changes passed in recent years have gone too far.
In a speech Tuesday at Columbia University, the former head of Goldman Sachs, who took over Treasury three weeks ago credits "corrective measures" in the wake of the corporate scandals at Enron and elsewhere for increasing investor confidence and playing a role in the economic recovery.
But Paulson also suggested that perhaps the series of corrective measures were too onerous and should be rolled back somewhat, noting, "Often the pendulum swings too far and we need to go through a period of readjustment."
He added that "there is no doubt" that certain legal and regulatory actions were critical to restoring confidence. But, he added, "The challenge before us now is how to achieve the right regulatory balance to allow us to be competitive in today's world while guarding against the recurrence of past abuses."
While the Treasury Secretary does not have the authority to change any governance-related regulations, his comments could embolden members of Congress and their business supporters who are calling for regulatory review and the rollback of some of the provisions of Sarbox.
Paulson avoided reference to specific regulations, but was most likely alluding to Section 404, the costly internal controls provision that has sparked the biggest backlash from the business community. Less clear is whether his comments reflect a shift in administration policy.
Asked last May about Republican congressional efforts to roll back portions of the controversial provision or exempt smaller companies from its requirements, Paulson's predecessor, John Snow told CFO.com, "The Administration hasn't taken a stand." However, he added, "Our view is that the SEC is in the best position to make those determinations."
In April, Christopher Cox, chairman of the Securities and Exchange Commission, said small companies should not expect an exemption from the internal-controls provisions of Sarbanes-Oxley. In a speech Cox gave to a Stanford Law School audience, he declared that, "Our emphasis is on making 404 work and implementing it in a cost-effective and investor-protected way, rather than simply waiving it."
Furthermore, at a conference on financial reporting held at Baruch College in May, then acting SEC chief accountant, Scott Taub, defended Section 404, insisting that, "If you think 404 does nothing for fraud, you're doing it wrong."
Both statements seemed to suggest that the SEC was unlikely to make more than minor modifications to the various provisions of Sarbox. One likely change: easing the auditing standards widely blamed for ballooning Sarbox costs. Last month, Cox named Conrad Hewitt as the new SEC chief accountant. In a press statement, Hewitt alluded to working with the Public Company Accounting Oversight Board to eliminate "excessive" auditing costs, possibly referring to reworking the PCAOB's Auditing Standard No. 2. Hewitt does not begin at the SEC until mid-August, and could not be reached for comment.
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Support for French Option Law Grows
Submitted by: Stacy Redding, International Custom Research Analyst, and Tad Kopinski, Staff Writer
Amid growing international concerns over stock option practices, a group of French lawmakers and politicians are backing legislation that would significantly limit the ability of company executives and directors to exercise their stock options.
The bill, introduced June 28 by former Prime Minister Edouard Balladur, would prevent board members and executives from exercising their stock options while in office. At least 138 of the National Assembly's 577 members have signed a request to put the legislation on the lower chamber's agenda, according to Challenges, the French electronic business journal.
In a July 14 interview, President Jacques Chirac said he favored the bill and asked his finance minister, Thierry Breton, to propose appropriate measures. While the bill has not been formally endorsed by the government, it likely will be, especially in light of presidential elections next year and the fact that Breton is the author of the 2005 law that requires greater transparency in executive pay, according to the daily Le Monde.
Medef, the union of French employers, has called Balladur's proposal to limit the exercise of stock options "absurd" and counter-productive because it would undermine executives' incentives to increase shareholder returns.
The legislation was proposed after news reports of stock options exercised by high-profile executives. Noel Forgeard, a former top executive at the EADS aerospace and defense company, earned 2.5 million Euros ($3.2 million) from exercising options weeks before a profit warning was issued. At the Vinci construction group, former Chairman Antoine Zacharias took home an estimated 250 million Euros ($320 million) after cashing in his stock options, in addition to a 13 million Euros ($16.4 million) severance package.
In a study published by L'Expansion, an online business journal, top executives at the CAC 40 companies hold stock options that are worth as much as 700 million Euros ($884 million).
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August 1, 2006 |
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EC Governance Priorities Get "Split" Response
Submitted by: Tad Kopinski, Staff Writer
The European Commission's report on corporate governance priorities found "split views on corporate governance," suggesting that support for new European-wide directives has diminished.
Internal Market Commissioner Charlie McCreevy attributed the results to "regulatory fatigue," but there was some consensus that the principle of "one share/one vote" needs to be addressed. The commission has ordered a fact-finding study on the proportionality between ownership and control in EU-listed companies, to be done by the European Corporate Governance Institute, the law firm of Shearman & Sterling, and ISS Europe.
Institutional investors represented only 12 percent of the 266 respondents who participated in the consultative process, while industry responses accounted for 25 percent of the total. In addition to the written comments, some 300 participants attended a May forum in Brussels on the Action Plan on Company Law and Corporate Governance.
According to the July 7 report, a slight majority of respondents supported proposals to improve shareholder rights, the nomination and dismissal of directors, and shareholder communication rules.
A majority of respondents opposed the adoption of a European wrongful trading rule, concluding that issue does not raise substantial cross-border problems. They also opposed legislation on directors' disqualification, on the grounds that substantial differences exist in the national rules across Europe.
Disclosure of institutional investors' voting policies also received only tepid support, with opponents noting that such a rule would impose excessive burdens on investors and is best left to contractual arrangements. However, a significant number of respondents insisted on the need to impose transparency and disclosure standards on institutional investors.
The consultations showed strong support for the adoption of a 14th company law directive, but some respondents raised doubts about the practical value of the directive since other obstacles, such as taxation and employee participation issues, would remain. There was also limited support for board structure changes and strong opposition to new rules on squeeze-out and sell-out rights. Finally, 28 percent of respondents called for a feasibility study on a pan-European statute to regulate foundations.
Meanwhile, the European Corporate Governance Forum (ECGF), a group of 15 experts that advise the EC, has endorsed the commission's proposed directive to improve shareholder voting rights. The group did not endorse another proposal that would require intermediaries to disclose to companies at least once a year the identity of the clients on whose behalf they hold shares.
"In cross-border situations, in which a chain of securities intermediaries exists between the company and the shareholder, all securities intermediaries in the chain will need to contribute to the exercise of voting rights by a shareholder, by passing on voting instructions or voting on the instructions of their clients, or by facilitating the granting of a proxy to vote to their clients," the ECGF said in a July 24 press release.
In another statement, the experts' group said the EU should not require stricter rules for risk management and internal controls, along the lines of Section 404 of the Sarbanes-Oxley Act. "The Forum, while confirming that companies' boards are responsible for monitoring the effectiveness of internal control systems, considers that there is no need to introduce a legal obligation for boards to certify the effectiveness of internal controls at EU level," the ECGF said.
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