The recession and financial crisis have shaken shareholders' faith in corporate boards and management. How can confidence be restored?
After the stock market carnage of the past two years, it's a tough assignment for companies: Win back suspicious and skittish investors. Though a recent stock market rally has helped dull some of the pain, investors are still stinging from their deep and unexpected losses in the stock market over the past two years.
If you were a Lehman Brothers or Bear Stearns shareholder, it's hard to forget the lesson you learned in 2008. Executives at those firms continued to reassure investors just days before things imploded. "How could your business be O.K. one week and finished the next?" asks Erick Maronak, who manages the Victory Large Cap Growth fund (VFGAX).
But it's not just these spectacular failures that disappointed shareholders. Investors complain of firms that took on too much debt or too much risk, or companies that handed CEOs who had been fired $100 million packages on their way out the door. Investors relying on income from equities feel especially let down: Nearly one-fifth of the companies in the Standard & Poor's 500-stock index have either cut or eliminated dividend payments since the start of the recession in December 2007. CEOs have been blamed: According to Challenger, Gray & Christmas, 616 public company chief executives have left their jobs since the start of 2008.
Boards Gone Missing
But never mind the CEOs, many burned shareholders wonder where were the boards of directors, who are supposed to be watchdogs representing them? "If that's the ideal, it's certainly drifted a long way off course," says John Merrill, chief investment officer at Tanglewood Wealth Management in Houston. "Boards of directors were either too tied into management or too lazy to do the independent research."
Not everyone agrees that corporations deserve such widespread criticism and skepticism. "The sins of the few have been visited on the many," says Lizanne Thomas, who heads the corporate governance practice at law firm Jones Day. Mistakes were made by "discrete pockets of industry," she says. "It's important as an investment and money manager that I don't get jaundiced by thinking every CEO is bad," adds Frank Holmes, chief executive and chief investment officer at U.S. Global Investors (GROW).
Still, all agree that companies, innocent and guilty alike, must do more to restore the confidence of investors. Many are already taking first steps, say investors and corporate governance experts. The first order of business, they say, is for companies to upgrade the way they communicate to shareholders. The key is brutal honesty, says Rich Myers, head of the financial communications practice at giant public relations firm Edelman. "Investors no longer have any tolerance for anything other than the candid truth," he says.
Costco is a Communications Leader
The sudden collapse of Wall Street firms with no apparent warning was an example of how not to handle a crisis. Management is responsible for giving investors as much information as possible. "If companies refuse to give you that information, do the smart thing and stay away," Maronak says.
Holmes worries that regulations and bureaucracy are slowing communication. Firms are "taking so long to get a message out to shareholders," says Holmes. As a CEO himself, Holmes tries to communicate to his shareholders in plain English and not "legal-ese."
Peter Iannone, director at CBIZ MHM (CBZ), which provides financial services for smaller companies, cites Costco (COST) as one example of a company skilled at communication, and not just with shareholders but also suppliers. "At the end of the day, it's about being accountable," says Iannone, who owns Costco shares. "The failure was undercommunicating in the past," Myers adds. "Err on the side of overcommunicating and being honest." But, while there's no point in sugarcoating the effects of the recession, executives can also take the long view, by talking about and planning for a firm's long-term growth prospects, Myers says.
Big Changes at BofA
Many firms have sought to assuage angry investors by changing management. Bank of America (BAC), for example, stripped the title of chairman from CEO Ken Lewis in April. In the past two months, five BofA board members have resigned. Beyond changes at the top, many shareholders and policymakers are pushing companies to change the way they're run by reforming corporate governance rules.
For example, Dan Nielsen, director of socially responsible investing at Christian Brothers Investment Services, asks companies for reforms like "say on pay," which would require shareholder votes on executive compensation packages, and separating the chairman and CEO into two jobs. Nielsen says companies have become much more receptive. "Several years ago, companies would receive a shareholder proposal and many would view that as an attack," he says. That's now less common. If a firm listens, and especially if it adopts reforms, "to me, that says that here is a company that doesn't have blinders on," he says. He cites Aflac (AFL) as a company that voluntarily adopted a "say on pay" provision.
Measures proposed in Congress and by the Securities & Exchange Commission would force some of these reforms on companies. Not everyone thinks these will help restore investor confidence, however. Thomas, the attorney at Jones Day, worries that more direct shareholder democracy will actually encourage boards and CEOs—ever fearful of losing their jobs—to pursue short-term strategies at the expense of long-term growth.
More Assertive Boards
Iannone says many compensation plans had the same effect by leading companies to take too many risks. "Boards of directors were establishing larger and larger compensation plans with such short-term focuses," he says. Instead, he favors plans that reward executives for long-term performance and for building strong balance sheets.
With or without structural reforms, more assertive boards of directors can help shareholders feel like they have an advocate. "The board and senior management need to have a relationship of trust," says Michael J. Missal, a partner at law firm K&L Gates. A former SEC attorney, Missal has often been hired by boards or others to investigate corporate scandals, including problems at WorldCom and subprime lender New Century Financial. "But, the board needs to have a healthy skepticism of senior management," he says. A red flag is board members handpicked by the chairman and CEO.
Brian Browning, senior vice-president at Valuation Research, is often hired by boards to provide an independent opinion on acquisitions and other transactions. Directors have become much more aggressive about asking questions, Browning says, a change from his past experience. "Now, when we provide opinions, boards want to understand everything we've done," he says. "They want to be more informed."
Dividends Make a Difference
More communication, different boardroom rules, or new compensation packages may ease some investors' concerns. But shareholders won't be truly happy until profits recover and growth strategies bear fruit. "I'm not sure there's a magic formula in terms of corporate governance," says Gordon Fowler, who manages $16.3 billion in client assets as chief investment officer at Glenmede Trust. He says he trusts firms and executives that have delivered in the past. "Generally, we only invest in management teams we have a heck of a lot of confidence in." Fowler says one way firms can win his trust is by paying shareholders a generous dividend. Unlike earnings or other accounting measures, "the dividend is a real number," he says. "It adds a level of accountability that is more immediate."
A company can communicate better, and change policies and personnel. But investors won't be fully inclined to trust Corporate America again until they see outperformance and firms better valuing—and rewarding—their shareholders. "Performance is everything," Thomas says. "Actions speak louder than words."