Posted by Carl Icahn December 10, 2008 : 3:06 PM
This post was also published on Harvard Law School Corporate Governance Blog
Eliot Spitzer offered up some insightful commentary (Nov. 16, Washington Post) on the public corporation's fall from favor and rightly pointed to basic issues in corporate governance that need reform. He states, "…our corporate governance system has failed. …Boards of directors, compensation and audit committees, the trio of facilitators (lawyers, investment bankers and auditors) whose job it is to create the impression of legal compliance, and shareholders themselves – all abdicated their responsibilities."
If by shareholders, Spitzer means mutual funds and pensions have not actively held boardrooms accountable, I agree with him. Put simply, boards have failed. Why should shareholders stand by on the sidelines? There is no axiom stating that public shareholders have to stand by and witness the demise of the most powerful financial engine in history.
Why should public shareholders be forced to leave so much value on the table because of risks taken by unaccountable management teams and boards? Spitzer says that when his office and the DOJ warned that, "some of AIG’s reinsurance transactions were little more than efforts to create the false impression of extra capital on the company's balance sheet," they were "jeered at for attacking one of the nation's great insurance companies, which surely knew how to balance risk and reward." Clearly, many boards such as AIG did not know how to balance risk. And they certainly did not know how to balance reward.
As owners, why would we allow this? The theory of the public corporation is not bankrupt, the practice is. We need critical changes in corporate governance that would go to the heart of the blameworthy lack of accountability between managers and shareholders.
Board members are often hand-picked by managers. The current proxy system is so biased in favor of management that any challenge is prohibitively expensive and generally guaranteed to fail. In theory of the corporation, the shareholders pick the board, and it in turn picks the management. In practice however, the system is turned upside down. Incumbent management picks the issues and board nominees for the proxy statements and distributes the ballots. The shareholders vote and sign their names to the ballots and then send them back to the incumbents, who count them and announce the outcome. And so, there is no true election. There is only one list of nominees! The system is similar to a dictatorship; the difference being that the goon squads protect the dictator, but lawyers protect the board.
And what is the result? Most recently, a financial crisis. Listen to Spitzer. "Boards of directors were also missing in action over the past decade; not only did they not provide answers, they all too often failed even to ask the appropriate questions."
This failure of corporate democracy has left shareholders virtually powerless. The system must be fundamentally reformed to give shareholders more rights – to nominate board members, to eliminate excessive takeover defenses and to have the ability to vote to incorporate their company in another state.
Simple legislation (see my post Shareholders Should Decide Where Companies Incorporate) would make tremendous progress toward resolving the power mismatch that managements and their boards have over shareholders. With true competition for board seats, accountability can be restored and managers would be compelled to work for value maximization on behalf of shareholders and not work simply to enhance their pay and perks and entrench themselves in highly paid positions.
Truly independent board members could also insist on performance based compensation plans and other programs to align management’s interests with shareholders. Then public shareholders could realize the full potential of their companies. But currently, the best opportunity for shareholders is to sell their shares and stand by while, in many cases, the same management team that ran their companies into the ground reap additional millions for a job poorly done.
These reforms are not just grist for academic debate. Reforms of our current system like 'Say on Pay' and golden parachute modification have received increasing support and several prominent corporations (including Aflac, Vodafone and GlaxoSmith Kline) have voluntarily adopted policies like Say on Pay.
At the very least, these reforms are essential to enhance management accountability for our corporations. Equally important, they would restore a basic democratic right to the owners of corporate America.
While the financial crisis continues, shareholders should have the option to protect their rights and make America's boardrooms accountable. Make a difference and join United Shareholders of America. This is where we start. It is where we grow stronger. It is where change begins.