Great Numbers, Weak Governance: Is AIG a Special Case?

By almost any measure, the board of insurance giant American International Group Inc. (AIG ) is a throwback. With 20 members, it seems too large to encourage meaningful discussion. With nine AIG execs holding seats, it includes far too many insiders. It even lacks a single currently active executive among its independent directors. Until only recently, the board also failed to have a separate nominating committee to ensure that its outside directors are truly independent.

Perhaps more troubling, seven of the inside directors, including Chairman and CEO Maurice R. "Hank" Greenberg, control and run two private companies that have substantial business dealings with AIG, leaving the execs open to charges of self-dealing and conflicts of interest. One of these companies is a veritable bank vault, paying out tens of millions in cash and stock to AIG executives outside the purview of the board's compensation committee. No wonder many governance experts consider the board among the weakest in Corporate America.

But don't tell Greenberg that. "Calling us one of the worst boards in America would be an atrocious distortion of fact," he says, pointing to the superior results the insurer has posted since he took it public 33 years ago as evidence that the unusual governance structure he set up then works.

There's no doubt that Greenberg has delivered outstanding results. He built AIG into a global powerhouse, the most successful insurance company in the world. Under his leadership, the insurer's market value has ballooned to more than $140 billion, up from just $452 million in 1969, when he took AIG public. Net income soared to $5.4 billion last year, up from $13 million in 1969. In the past five years, it has handily outperformed its peers and the Standard & Poor's 500-stock index.

Most shareholders aren't overly concerned about AIG's governance. "There's not a lot that I can complain about based on what this company has delivered," says Kevin W. Callahan of Boston-based Century funds, which own more than 450,000 AIG shares. "This is a strong, well-managed company."

Is AIG a special case? Or is Greenberg clinging to a governance model more appropriate to a private partnership that does not avail itself of the public capital markets?

At least by the standards of governance experts, AIG's unique structure doesn't stand up. Some critics say the strong-willed Greenberg is out of touch, resisting the expectations that shareholders now place on public corporations. Until two years ago, insiders made up the majority of AIG's board. When Greenberg served on the New York Stock Exchange's governance committee earlier this year, he was in the losing minority in arguing that a board should not be required to have a separate nominating panel.

"It's an old-style board dominated by a charismatic and highly successful CEO," says Charles M. Elson, director of the Center for Corporate Governance at the University of Delaware. "Investors are basically jumping out of an airplane with him without a parachute. The standard governance protections aren't there."

Greenberg would beg to differ. He's effectively arguing that his company's stellar performance is, by definition, evidence of a strong board and good governance. The critics, however, argue that shareholders rarely know the value of a well-functioning board until a crisis hits, and they say that the governance practices at AIG don't inspire confidence.

After all, even the Business Roundtable insists that all major public corporations should now have a "substantial majority" of independent directors, not merely a simple majority, as at AIG. Greenberg argues that the large number of inside directors, who together own 25% of AIG's outstanding stock, allows for more meaningful discussion. "Their interests are directly aligned with those of the shareholders," he says. "Is there a guarantee that if we had more outside directors, the company would have done much better? I would challenge that."

As for the outside directors, who are mostly retired, Greenberg insists they have more time to devote to their board duties than fully employed execs. And he defends their credentials. "How many people can I get who understand trade issues with Japan and China as well as [former U.S. Trade Representative] Carla Hills?" he asks. "Who knows more about infrastructure funds around the world than Barber Conable, who ran the World Bank? Christ, this is a good board."

With governance front and center in the minds of shareholders, Greenberg has made some concessions. He has added an independent nominating/governance committee, stopped the fees the company paid director Hills and the law firm of board member M. Bernard Aidinoff, and put a majority of outsiders on the board's executive committee, which can act when the full board is not in session. Addressing charges that there was no succession plan in place, the 77-year-old Greenberg also has named co-chief operating officers and established a seven-person office of the chairman.

Many of AIG's idiosyncrasies date back to 1969, when Greenberg took AIG public. He wanted access to public capital for his ambitious growth plans, but, with a core group of insiders, he also wanted to retain an unusual degree of ownership and control. "I wanted to maintain a quasi-private-company mentality in managing a public company," he says. "We have the best of both worlds."

Rather than taking the full value of their holdings when AIG went public, he and several other insiders took only the book value of the stock. The difference--roughly $110 million in AIG stock--was ultimately stashed away in Starr International Co. (SICO), a Bermuda company. The value of those shares has grown to more than $20 billion, representing some 12% of AIG's outstanding shares. SICO has little business purpose other than to reward current and future AIG executives--above and beyond what they receive directly from AIG.

Some 600 of AIG's top executives get "units" that represent AIG shares or cash from a compensation plan that is not administered by the compensation committee of AIG's board. The rewards also function as golden handcuffs, because they cannot be collected until an employee retires after reaching age 65. In 2000, Starr dished out bonuses worth more than $55 million to the company's top five officers, including $23.7 million to Greenberg alone.

"It's a unique arrangement in a company of that size," says Kenneth A. Bertsch, director of corporate governance at TIAA-CREF, the teachers' pension fund. One result, he says, is that AIG's stock options represent just 3.5% of outstanding shares--far below the 15% threshold the fund has set for companies in its portfolio.

Greenberg makes the same point, arguing that shareholders benefit greatly from this highly unusual plan because AIG doesn't have to pay out as much compensation. "If we didn't have that, the options outstanding at AIG might be 5 or 10 times as great," he says. What we've done is so misunderstood. There has never been a more generous act on the part of a group of people in Corporate America."

But governance critics note that a separate compensation scheme controlled by Greenberg and a handful of insiders can have a perverse effect. "Since the top officers control it, the compensation program could stifle any dissent that could legitimately come before the board," says Delaware's Elson. "It creates a company within a company that is at odds with the transparency we expect from a public corporation."

Yet another private outfit, C.V. Starr & Co., has a small collection of insurance agencies that were losing money when Greenberg took AIG public. He says he didn't want to saddle AIG's new investors with the business. So he and the same group of insiders kept ownership of the now-profitable agencies. If they had included this business in the original AIG public offering, however, AIG's shareholders may have realized benefits from that turnaround. Last year, AIG paid $77 million in commissions to this private entity, run and controlled by Greenberg and other AIG insiders.

Isn't that a blatant conflict of interest? Not at all, argues the CEO. Greenberg maintains the transactions are at arm's length and often are less advantageous to the Starr agencies. "We try to bend over backward to be even more evenhanded," he claims. "AIG gets hundreds of millions of dollars in premiums that way. Where's the conflict?"

Until now, investors have placed their faith in Greenberg's extraordinary abilities, and he has certainly earned their trust. He is a one-of-a-kind entrepreneur who has built a one-of-a-kind company. Whether Greenberg's form of governance could survive after he's gone is another question.

By John A. Byrne

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