Corporate Governance: Important Trends

John M. Holcomb

Institute for Enterprise Ethics

May 14, 2015

Topics Ethics and Compliance Corporate Political Activities Shareholder Activism Executive Succession Cybersecurity

Reputational Risk Management Failures in crisis management

BP: Wrong leader in Hayward; Lax assessment of risk; Failure to implement message on safety; Cozy relationship with regulator; Abuses in victim compensation plan

News Corp: Failure of internal controls on hacking and privacy invasion; Cozy relationship with police and governmental elites

GM: No upward communication of bad news; tradition of blaming others; Group think; board in denial

Lufthansa and Germanwings Crash Suicidal co-pilot and tragic passenger deaths Company was aware of co-pilot’s history of depression

and his previous treatment and leave of absence Lack of scrutiny in allowing him to return Current strategy of reliance on low-cost carriers Supervisory board of 20 members

10 are employee representatives 5 are women Robert Kimmitt is American representative

Ethics and Supply-Chain Management Major problem for several companies

Nike in southeast Asia, and Wal-Mart Apple and Foxconn Several companies and factory burnings in

Bangladesh Levi Strauss and control of labor practices by

contractors in China and southeast Asia. Rainforest Action Network partnership with

Home Depot on old growth forests

Importance of Roles of Board Compliance and Corporate Responsibility Committees Taking Caremark duty seriously to monitor internal controls Mitigating factor under Sentencing Commission guidelines Avoiding a charge under the McNulty Memo Complying with conditions of deferred prosecution

agreements or legal settlements Adapting to onerous burden placed on audit committees Realizing the limits of the 3 major committees – audit,

compensation, nominating committees Prevention of future fraud and legal violations

Why and How to Examine Roles of Board Compliance/Public Responsibility Committees

Penetrating any smokescreen or sham Going beyond the labels Content analysis of committee charters Length of committee charters Frequency of committee meetings Examining the numbers of women on board

committees Separating the crucial from the important

Fortune 200 Non-Audit Committees with Compliance Roles Company Committee  Abbott Labs Public Policy Johnson & Johnson Regulatory, Compliance,

and Government Affairs

Pfizer (Ironic) Regulatory and Compliance

Amgen Corporate Responsibility and

Compliance AIG Regulatory, Compliance,

and Public Policy

Non-Traditional Board Committees 101 of the Fortune top 200 companies have board

committees on: Public responsibility, Sustainability, Risk management, EHS, or Regulatory compliance and risk

Public responsibility committees have an external focus while ethics and compliance committees have an internal focus.

The former are important, while the latter are crucial Best Practices: Wells Fargo has three such committees

Whistleblower Protection SEC reports that all but one whistleblower filing a complaint

under Dodd-Frank law had complained internally first and exhausted internal channels.

Payouts of $50 million so far to 15 whistleblowers Retaliation and pretaliation (action to prevent whistleblower) KBR case – SEC cracking down on confidentiality agreements Exceptions allowing corporate attorneys to blow the whistle:

Significant harm to investor Company has actively impeded the investigation Internally reported and no action taken within 120 days N.B.: May also be ethically obligated to then blow the whistle

New Rules Disclosure of investments in conflict minerals – Amnesty

International and Global Witness Report that 80 percent of companies are not in compliance; high expense for limited benefit

Rule on disclosure of pay and performance Comparison to peers Total shareholder returns, including dividends, over 5-

year period Compensation actually paid in a given year Pay gap rule yet to come

Impact of Citizens United decision on Corporate Political Involvement Business PACs Shun Endorsement Campaigns Reputational Damage Shareholder Opposition Business Shuns Independent Committees

Morgan Stanley has refused to engage in independent spending and relies on PAC

GM used bailout money to fund candidates Continued Reliance on PACs Nonprofit Groups, Super PACs, and Wealthy Donors Benefit

over the Political Parties

Roles of the Center for Political Accountability Created a model shareholder resolution Created corporate rankings and scorecard Basic emphasis is on disclosure – discussion

of disclosure on later slide

Highest Ranking Companies By all measures, IBM is the gold standard. It has a long-

standing policy prohibiting the use of corporate money for political spending. The company also has no PAC and received a perfect score in a comprehensive report by the CPA published late last year.

Still, its investors then wanted to know how much in dues the company pays to trade associations and “other organizations that can hide any contributions.” And they want a comprehensive report on lobbying activities.

Highest Ranking Companies in Political Disclosure In the CPA’s latest 2014 survey report, CSX

and Noble Energy rank the highest on political accountability and disclosure of political activities.

Rounding out the top ten are Becton Dickinson, Capital One, Exelon, Qualcomm, UPS, AFLAC, and Biogen

Model Resolution of the Center for Political Accountability Report soft money contributions, independent

expenditures, and payments to trade associations and other tax exempt organizations that are used for political purposes;

Identify the titles of the individuals involved in the expenditure decisions;

Disclose their political spending guidelines; and Require the board of directors to conduct oversight

of the company's political spending.

Critique of CPA Criteria Ignore key elements of corruption Inclusion of items unimportant to investors Using PAC as exclusive avenue is not even

scored Danger in check-the-box test CPA enjoys a monopoly on setting the

standard; comparison to governance ratings

Key Elements of Corruption Ignored Direct lobbying – ten times the amount

contributed to candidates Contributing to political party conventions Contributing to 501c-3 nonprofits and

foundations tied to candidates Giving specifically to judicial elections and to

candidates for state attorney general Bundling

New Scoring and Ranking Results Questions added and method – top 2 tiers Every company’s score is lowered Some in upper tier move to lower tier, and

vice versa Lots of changes in rank orders Some make dramatic moves upward

Questions Added to List of Criteria Does the company have a policy restricting bundling of political

contributions by executives? Or: Does the company disclose the money raised through bundling and then

contributed to political candidates? 6 Points Does the company restrict and/or disclose contributions to political party

conventions? 2 points Does the company restrict contributions to public policy think tanks or

foundations that have been established by or affiliated with political candidates? 2 points

Does the company disclose the amount it spends on direct lobbying of Congress or other branches of the federal government? 2 points

Does the company disclose the amount of money it spends on direct lobbying of state legislatures and/or foreign governments? 2 points

Questions Added to List of Criteria Does the company disclose the amount of money it pays to law firms or

political consultants to represent its political interests in the national or state capitols? 2 points

Does the company prohibit contributions to super PACs or c-4s? 4 points Does the company disclose amounts spent on super PACs or c-4

Committees? 4 points As to question 11 in the CPA list, it should not simply be a yes/no

question but should be allocated 6 points, with full credit given to those companies that restrict political contributions through the PAC, the legally authorized component. Companies that also ban PAC contributions should not be given more credit for political responsibility, but should be penalized.

Lower Scores with New Criteria Old Scores New Scores 90-100 A 20 80-89 B 32 70-79 C 35 60-69 D 17 0-59 F 0

90-100 A 0 80-89 B 0 70-79 C 20 60-69 D 51 50-59 F 33

Tier 2 to 1 Tier 1 to 2 Anadarko Petroleum Applied Materials Reynolds American Boston Scientific Eli Lilly Lockheed Martin

Air Products & Chemicals

Costco Illinois Tool Works Dow Chemical eBay CVS Caremark

Dramatic Move Upward for Some Pfizer

In rank 11 by CPA score In rank 6 by new score

Applied Materials In rank 17 by CPA score In rank 12 by new score

Shareholder Activism and Proxy Fights Tempur Sealy case – CEO, Chairman, and head of

governance committee all resign under investor pressure from H Partners hedge fund (10% owner); Four proxy advisory firms supported negative votes

DuPont/Trian case – “white hat” activist wanted seat on the board for Peltz; ISS backed all four Trian candidates while Glass Lewis only supported Peltz; DuPont not a broken company; Lipton acknowledged Peltz would bring value to the board

Reactions to Activist Shareholders Success rate of activists is declining More push-back from company boards Targets are now smaller companies of less

than $10 billion in assets Former activists will now settle more easily

and are focusing on other issues New players are emerging

Reactions by Opponents Fink of BlackRock

Advises firms not to pander to investors and decries short-termism

Opposes higher dividends and buybacks Advocates shifting tax policy to favor long-term

holdings Marty Lipton: “Activism has caused companies to cut

R.& D., capital investment and, most significantly, employment. It forces companies to lay off employees to meet quarterly earnings. It is a disaster for the country.”

Reputational Risk Management: Failures in Leadership and Succession Planning Hewlett-Packard: multiple chapters – from

Fiorina to Hurd to Apotheker to Whitman Invading privacy of board members and reporters

( by board chair Patricia Dunn) Questionable personal relationship and expense

account fraud (Hurd) Strategic missteps (Apotheker) Board in disarray (due to privacy scandal and

disagreements over leadership and strategy)

Failures in Leadership and Succession Planning cont.

Pfizer: from McKinnell to Kindler Preoccupation with Washington and status

(McKinnell) CEO Compensation scandal (McKinnell) Autocratic micro-management (Kindler) Reliance on the misjudgments of an HR officer

(Kindler)

Cyber security and Cyber attack Risks Target case

Has not yet recovered Board was targeted by investors

Concern over supply chain Prevention versus detection Private sector and public sector responsibilities Board skill set

Difficult to find board candidates Tech expertise does not necessarily coincide with business

expertise Committee domain – risk, audit, regulatory compliance