Corporate Governance

Views and Analysis

On this page

• New Manual for Corporate Managers Sees Value in Integrating Multiple Business Priorities
• Book Review: "Bribery and Extortion – Undermining Business, Government and Security"
• CED Voices Criticism of "Short-Termism"
• Apples to Apples: Model Template for Earnings Statements
• TIAA-CREF New Corporate Governance Policies
• Apple, Jobs, Backdating: Governance Double-Standard?
• Conference Proceedings: "Business Ethics in the Corporate Governance Era"
• U.S. Governance Seen From Europe
• Breaking the Short-Term Cycle
• Robert Repetto on Corporate Lobbying and Board Oversight
• CED Policy Report on the State of Corporate America
• Vivek Wadhwa on Board Responsibility

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New Manual for Corporate Managers Sees Value in Integrating Multiple Business Priorities

The Business Roundtable Institute of Corporate Ethics (ICE) conducts a special series on ethics and leadership.  The purpose of the series is to provide current and future business leaders with knowledge and insight needed to create and sustain successful organizations.  The first publication in the series is called Managing for Stakeholders: Survival, Reputation, and Success. It emphasizes the need for an organization to address all of its relevant stakeholders, which has particular relevance to the corporate social responsibility movement.  Instead of thinking about stakeholders as a balance of trade-offs, the book analyzes decision-making as an opportunity for value-creation for all stakeholders.  The publication has already been hailed by many business school professors and business leaders as a must-read for business managers everywhere. 

The following is an introduction to the new book which appears on the ICE website. 

Managing for Stakeholders: Survival, Reputation, and Success

By R. Edward Freeman, Jeffrey S. Harrison, and Andrew C. Wicks
Volume I in the Institute Series in Ethics and Leadership

Managing for Stakeholders: Survival, Reputation, and Success, the culmination of twenty years of research, interviews, and observations in the workplace, makes a major new contribution to management thinking and practice. Current ways of thinking about business and stakeholder management usually ask the Value Allocation Question: How should we distribute the burdens and benefits of corporate activities among stakeholders? Managing for Stakeholders, however, helps leaders develop a mindset that instead asks the Value Creation Question: How can we create as much value as possible for all of our stakeholders?

Business is about how customers, suppliers, employees, financiers (stockholders, bondholders, banks, etc.), communities, the media, and managers interact and create value.

World-renowned management scholar R. Edward Freeman and his coauthors outline ten concrete principles and seven practical techniques for managing stakeholder relationships in order to ensure a firm’s survival, reputation, and success.
Managing for Stakeholders is a revolutionary book that will change not only how managers do business but also how they recognize and evaluate business opportunities that would otherwise be invisible.

This relatively small change in mindset has enormous impact—moving managers from a reactionary and defensive posture that focuses on dilemmas to a proactive and collaborative one focused on opportunities.

Success is not about making tradeoffs among these stakeholders, but understanding how their interests can be united. Success is creating products and services that simultaneously serve the interests of customers, suppliers, employees, communities and financiers.

Managing for Stakeholders arms current and future business leaders with skills and knowledge critical to leading and sustaining a successful business in the midst of a rapidly changing environment.

For more information about this publication, contact Brian Moriarty, the Associate Director of Communications.

The Business Roundtable is an association of corporate executive officers and a partner in the establishment of the Institute of Corporate Ethics.  The Institute itself is an independent entity housed in the University of Virginia’s Darden Graduate School of Business Administration.

Posted 5/13/08

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An Ethicsworld Book Review

New Book Provides A Valuable Anti-Corruption Introduction for Business and Law Students and New Entrants to Multinational Companies

"Bribery and Extortion – Undermining Business, Government and Security" By TRACE President Alexandra Addison Wrage, Praeger publishing, available from Amazon.

Corruption is a curse. It wrecks the lives of people across the world, it undermines democracy, it ruins companies, and it is doing enormous damage to the environment, argues Alexandra Wrage in her new book. The volume is a convincing case against bribery with dozens of examples that highlight the mechanics of how bribes are paid, offered and extorted.

Far too many business and law schools and multinational companies assign marginal importance to anti-corruption education: this book should be widely used to make future and current international corporate managers recognize the folly of bribery.   There is a basic message that needs to be more broadly accepted in business, which is succinctly phrased by the author: "Every act of complicity encourages the corrupt. Every bribe paid, however casually, shapes the expectation of the recipient for all future transactions. Every bribe resisted, on the other hand, is a tiny victory for the individuals involved, for the larger community, for decency, and for the rule of law." 

Alexandra Wrage is blunt in decrying the use of "facilitating payments," when companies make small payments to foreign officials, that are legal under U.S. law.  Quite apart from their illegality in the countries where they are made and their immorality, they are bad for business. They contribute to the corroding of a company’s ethical culture. They can hurt the reputation of firms. Indeed, says Wrage, an increasing number of companies are now growing tired of making these petty bribes and they are working to end the practice – this is about the only good news evident in this powerful book.

The many cases of governmental bribe-taking and of extortion of bribes create a picture of vast numbers of victims: ordinary people who fail to receive the security, the basic services and the core rights that they deserve because of the criminality of their governments. Indeed, says the author, there are many examples of unchecked governmental corruption that have led to such consequences, and she adds that civil and social conditions become far more grievous when the military is also thoroughly corrupt.

The author is unequivocal in declaring that habits of bribery do intense harm to businesses. "Bribery and Extortion" details convincingly that bribes "increase the cost of doing business.  They are an additional, often unpredictable expense. It is difficult to budget for bribes and bribes aren't tax deductible in the way that other business expenses are. Bribes buy an unenforceable contract."

A portion of the book is devoted to what is being done to stop bribery. The number of official investigations is gradually rising and greater awareness of the risks is proving to be a modest disincentive, it seems. Furthermore, the author is encouraged that an increasing number of conventions, culminating in the United Nations Convention Against Corruption, are creating a global framework of laws that serve as a basis to increase efforts now to bring bribe-payers and bribe-takers to justice.

To read Alexandra Wrage's article "Small Bribes Buy Big Problems," click here.

Visit TRACE website.

Posted 9/10/07

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CED Voices Criticism of  “Short-Termism”- Releases Recommendations On U.S. Corporate Governance

An increasingly short-term focus by many business leaders is damaging the ability of public companies to sustain long-term performance, according to a new report on Corporate Governance by the Committee for Economic Development (CED).  Built to Last: Focusing Corporations on Long-Term Performance, was released on June 27, 2007.

The Committee for Economic Development (CED), a U.S. business-led policy group, called on corporate boards of directors to act to prevent current widespread practices that impede the longer-term value of companies, such as placing emphasis on quarterly earnings, compensation tied to earnings per share, shortened CEO tenures, and financial reports that fail adequately to inform about company performance.

CED’s Subcommittee on Corporate Governance, which published this report, was chaired by former Securities and Exchange Commission Chairman William Donaldson (disclaimer – EthicsWorld publisher Frank Vogl is a Trustee of CED and a member of the Governance subcommittee).

Recommendations
The new report argued that corporate boards of directors can:

• Support management’s development of comprehensive strategic plans with appropriate, long-term objectives and continually assess management’s performance vis-à-vis those objectives and interim milestones.

• Structure incentive compensation plans so that a significant portion of the income of the CEO and other top executives is tied to the achievement of well articulated, long-term performance objectives in line with the corporate strategy.

• Insist that corporate reporting be redesigned to include useful non-financial indicators of value, such as those proposed by the Enhanced Business Reporting Consortium, and that such measures count internally for assessment of performance.

• Eliminate quarterly guidance on earnings per share. Such guidance encourages a focus on (and sometimes a distortion of) short-term financial results and attracts short-term, speculative trading rather than long-term investing.

• Promote succession plans that emphasize growth of internal managerial talent. Doing so would help diminish reliance on costly contracts for recruited executives and may counter the pressure to achieve short-term performance.

The report’s central message is that Board of Directors needs to strengthen the focus of companies on the longer-term. Additional recommendations include:

• Acting in the shareholders’ interests, the board should constructively engage with management to promote the development of long-term strategies. Such engagement should avoid the pitfall of micromanagement; rather, it should focus on the process of reviewing, appraising, and enriching management’s plan, and on holding management accountable for its continuing evolution and execution.

• Be vigilant in constructing executive compensation pay packages that motivate executives to maximize the company’s long-term economic value.

• Align company executives’ financial interests and incentives with the long-term health of the company and its stock price. For similar reasons, directors also should be required to buy and hold the company’s shares.

• Engage major shareholders in a dialogue about executive compensation programs.

• Ensure that the company has a strong succession plan and grows managerial talent internally, and consider alternatives to contracts at the CEO level. When contracts are necessary, they should be carefully devised to foster the achievement of the company’s long-term goals during a realistic time frame.

• For their internal assessments of performance, CED recommended that directors encourage management to adopt reporting systems that focus attention on “value drivers” and long-term risks, such as those proposed by the Enhanced Business Reporting framework. Directors may consider requesting reports on such metrics as part of the information provided in the board package. Companies also should voluntarily provide information derived from those systems to complement public financial reports.

To view full report, click here.

CED is a non-profit, non-partisan organization of more than 200 business leaders and university presidents. Since 1942, its research and policy programs have addressed many of the nations most pressing economic and social issues, including education reform, workforce competitiveness, campaign finance, health care, and global trade and finance.
CED promotes policies to produce increased productivity and living standards, greater and more equal opportunity for every citizen, and an improved quality of life for all.

Posted 6/29/07

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Apples to Apples: A Model Template for Responsible Earnings Statements

The way that companies release earnings statements significantly impact the degree of “short-termism” in the corporate world, says a new report from the CFA Centre for Financial Market Integrity, an international non-profit that addresses ethics in the investment profession, and the Business Roundtable Institute for Corporate Ethics, a non-profit research and education organization. The report, “Apples to Apples: A Template for Reporting Quarterly Earnings” draws on an earlier report by the two organizations, “Breaking the Short-Term Cycle,” (see below) which outlines strategies for combating harmful short-term decision-making by businesses and investors. ‘Apples to Apples’ recommends that all public companies voluntarily adopt a consistent template for quarterly earnings releases and provides a model template reflecting the recommendations.

The following are excerpts from the “Recommendations” section of the report:

In order to improve the quality of communications between companies and investors, we
strongly urge companies to issue quarterly earning reports that:

• End quarterly earnings guidance: The current practice of focused quarterly earnings guidance inadequately accounts for the complex dynamics of companies and their long-term value drivers. The costs and negative consequences of the current focused, quarterly earnings guidance practices are significant, including:

1. unproductive efforts by corporations in preparing such guidance,
2. neglect of long-term business growth in order to meet short-term expectations,
3. a “quarterly results” financial culture characterized by disproportionate reactions among internal and external groups to the downside and upside of earnings surprises, and
4. macro-incentives for companies to avoid earnings guidance pressure altogether by moving to the private markets.

• Include a GAAP income statement that starts at the revenue line and proceeds to net income: Although the information necessary to reconcile the text of the earnings release and the GAAP financial income statement data is often contained in the release, it is too often unnecessarily cumbersome and challenging to find and piece together. Current reconciliation tables to GAAP data are too often confusing and obscured within the earnings announcement.

• Position GAAP reconciliation tables in immediate proximity to the non-GAAP financial measures they are meant to illuminate: The [GAAP reconciliation] table should clearly present the management adjustments from GAAP net income to the particular metric management
has defined as most useful for understanding the financial status of the firm.

• Include a balance sheet and statement of cash flows: A balance sheet and statement of cash flows, along with any relevant reconciliation tables, should be included in the release. In addition, we encourage expanded discussion of balance sheet and cash flow items as appropriate. The balance sheet and cash flow information should be sufficiently representative so that it is possible to reconcile income statement items that have a direct cause or effect on the balance sheet or cash flow statement.

• Place information consistently: While we acknowledge the need for flexibility and the variety of considerations related to the release of corporate information, we encourage the consistent placement of all tables and reconciling information within the release. Specifically, we recommend placement of such information at the front or the end of all future quarterly releases.

For the full report click here.

Posted 4/9/07

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TIAA-CREF Issues New Edition of its Policy Statement on Corporate Governance

TIAA-CREF, a US financial and retirement services organization released a newly revised 5th edition of its Policy Statement on Corporate Governance which is written to inform investors, companies and the public about what TIAA-CREF considers sound corporate governance and responsibility policies (3/13/07). The new statement covers best practices in shareholder rights, director elections, board structure and processes, international governance, and includes updated policies on majority voting,  executive compensation, and environmental and social issues.

Among the reports suggestions:

Director Elections

1. Directors should be elected by a majority rather than a plurality of votes cast.

2. In the election of directors, shareholders should have the right to vote “for,” “against,” or “abstain.”

3. In any election where there are more candidates on the proxy than seats to be filled, directors should be elected by a plurality of votes cast.*

4. To be elected, a candidate should receive more votes “for” than “against” or “withhold,” regardless of whether a company requires a majority or plurality vote.

5. Any incumbent candidate in an uncontested election who fails to receive a majority of votes cast should be required to tender an irrevocable letter of resignation to the board. The board should decide promptly whether to accept the resignation or to seat the incumbent candidate and should disclose the reasons for its decision.

6. The requirement for a majority vote in director elections should be set forth in the company’s charter or bylaws, subject to amendment by a majority vote of shareholders.

7. Where a company seeks to opt out of the majority vote standard, approval by a majority vote of shareholders should be required.

Executive Compensation

7. While Compensation Committees should consider comparative industry pay data, it should be used with caution.

9. Compensation Committees should work only with consultants that are independent of management.

10. Consistent with SEC requirements, the CD&A should provide shareholders with a plain English narrative analysis of the data that appear in the compensation tables. The CD&A should explain the compensation program in sufficient detail to enable a reasonable investor to calculate the total cost and value of executive compensation, to understand its particular elements, metrics and links to performance, and to evaluate the board’s and executive management’s underlying compensation philosophy, rationale and goals.

12. Compensation plans and policies should specify conditions for the recovery (clawback) of incentive or equity awards based upon reported results that have been subsequently restated and that have resulted in unjust enrichment of named executive officers.

Equity-Based Compensation

1. The use of equity in compensation programs should be determined by the board’s equity policy. Dilution of shareholder equity should be carefully considered and managed, not an unintended consequence.

3. Equity-based plans should take a balanced approach to the use of restricted stock and option grants. Restricted stock, which aligns the interests of executives with shareholders, permits the value to the recipient and the cost to the corporation to be determined easily and tracked continuously.

5. When stock options are awarded, a company should consider: (i) performance-based options which set performance hurdles to achieve vesting; (ii) premium options with vesting dependent on a predetermined level of stock appreciation; or (iii) indexed options with a strike price tied to an index.

6. Equity-based plans should specifically prohibit “mega grants,” defined as grants to executives of stock options whose value at the time of the grant exceeds a reasonable multiple of the recipient’s total cash compensation.

7. Equity-based plans should establish minimum vesting requirements and avoid accelerated vesting.

8. Companies should support requirements for stock obtained through exercise of options to be held by executives for substantial periods of time, apart from partial sales permitted to meet tax liabilities caused by such exercise. Companies should establish holding periods commensurate with pay level and seniority.

10. Backdating of option grants should be prohibited. Issuance of stock or stock options timed to take advantage of nonpublic information with short-term implications for the stock price should also be prohibited.

12. Disclosure should include information about the extent to which individual managers have hedged or otherwise reduced their exposure to changes in the company’s stock price.

Posted 3/14/07

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Apple, Steve Jobs, and Options Backdating:
A Double Standard for Corporate Governance?

To download as .pdf

As Apple’s Chairman and CEO, Steve Jobs, launched Apple’s iPhone (a cell phone equipped with e-mail and Apple’s best-selling iPod technology) raising the company’s shares up over 8 percent to a record high price, the company’s leader “continues to face scrutiny for his role in options backdating,” reported the Financial Times on January 10, 2007. 

Numerous media reports are highlighting the controversial decision by Apple’s Board of Directors to keep the company’s exceptionally successful founder and leader in his position, despite evidence that he knew of stock options backdating - a practice that has recently forced resignations by CEOs at other major companies.

More than 150 U.S. companies are under investigation by U.S. authorities because of unreported options’ backdating for senior executives, which enabled many of these executives to secure major financial benefits.  Apple established a two-member special Board committee (consisting of former U.S. Vice President Al Gore and former Apple Board Compensation Committee Chairman Jerome York) to review Mr. Jobs’s alleged involvement in this practice.  The company issued a December 29, 2006 report stating that the CEO had knowledge of, and in some cases recommended, the backdating. The Board, however, announced that it found “no misconduct” by Mr. Jobs or other managers.
 
Business Week, in its January 15, 2007 issue, reported that the U.S. Securities and Exchange Commission is scrutinizing Apple’s internal audit as part of a formal investigation into the company’s backdating. The Apple Board’s own report stated that Mr. Jobs knew about some of the 6,428 option grants handed out between late 1996 and early 2003 – roughly 15% of the total number of option grants in this period – that were improperly dated to ensure special benefits and that, in fact, he even recommended the dates. The magazine’s article by reporter Peter Burrows quotes Alan Johnson of Johnson Associates, a compensation consulting firm in New York, as commenting: “He knew what he was doing. It wasn’t ‘the dog ate it.’ He backdated the options on purpose and the committee said it will give him a free pass.”

The magazine points out that the fortunes of few major companies have been so closely tied to that of its founder as Apple and that this is very widely appreciated, which may have made it particularly difficult for the Board to consider firing Mr. Jobs over this issue, especially as it is unclear to what he extent he may personally have secured additional compensation as a result of actions on his own stock options. The article, for example, suggested that numerous Silicon Valley companies are troubled by the latest developments and the example they set. Business Week quoted William P. Roelandts, CEO of computer chip manufacturer Xilinx Inc., as stating: “It looks like Apple’s board is trying to whitewash the situation because they like him so much.”

The San Jose Mercury News (the local newspaper for the “Silicon Valley” tech companies in California) reported on January 10, 2007,  “Apple's internal review of options manipulation identified no misconduct by current executives. But if regulators come to different conclusions, they could press for sanctions against the company and pursue civil or criminal charges against individuals.” The article added, “Apple's board has expressed its ``complete confidence'' in Jobs and current executives, but regulators aren't likely to be satisfied, experts predict. Instead, they're likely to examine documents, interview key players and review evidence.”

The ethics standards at Apple may be brought to the fore by some irate shareholders. The San Francisco Chronicle, on January 4, 2007, quoted Patrick McGurn, a senior vice president with Institutional Shareholder Services as saying, “A big storm cloud cleared for Steve Jobs. But there are more storm systems moving in."  But, the article also quoted experts as suggesting that given that Apple’s Board investigated before an official SEC investigation, and given that former Vice President Gore has backed the Board’s confidence vote in Mr. Jobs, the Federal Government may not pursue this matter further.

But, at a variety of companies, the Boards of Directors concluded that the actions of top executives engaged in past options backdating were unethical, if not illegal and that the publicity was so damaging to the ethical reputation of the companies that forceful actions had to be taken. It was against this background, for example, that the very successful chairman and CEO of the nation’s largest healthcare company, Dr. William W. McGuire of United Health, was forced to resign in December.

1/10/07

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Seattle University
Albers School of Business & Economics

Now Available:

Proceedings from the Conference, "Business Ethics in the Corporate Governance Era"

http://www.seattleu.edu/asbe/abei/proceedings.asp

Including a remarkable range of talks and papers by scholars and practitioners from around the world.

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U.S. Governance, Seen From Europe
Americans Should Think More About Stakeholders, says Siemens' Klaus Kleinfeld

By William J. Holstein

Reproduced with permission from Directorship, the online and print business resource for Directors

American Executives and boards should take a broader view of their responsibilities to shareholders and keep in mind the interests of many "stakeholders," says Klaus Kleinfeld, the Munichbased CEO of Siemens. But they should not necessarily embrace the German model of including unions on their supervisory boards. Here are highlights from a conversation conducted in New York:


In German corporations, the CEO chairs a management board that in turn reports to a supervisory board. Is that a better governance model than the one-board system that American companies use?
This is one of the debates that you've been having after Enron and WorldCom. There's been research. The data I've seen is that you cannot boil it down to the structure. You have to basically go to the individuals who are involved. If the individuals can work very well together, if the chemistry is right, if there's a good operational mode, it can be done in a very positive way. I would not overplay the structure. Bear in mind that Enron had split the role of chairman and CEO, which at that time was the exception to the rule. I think structure is overplayed.


What are your observations about the fluidity here among CEOs, boards and shareholders?
At the end of the day, it boils down to having a great management team that can act fast because today's world market is a fast competitive environment. My mantra has always been "Nobody's perfect." But a team can be. I believe that. In today's world, this is even more essential for reasons of increased complexity on a regional basis as well as on a technology basis.


Is there a risk that if American CEOs are engaged in hostile relationships with boards, they may not be able to respond quickly enough?
My impression is that if the American CEOs don't have good relations with their boards, they aren't going to last. In today's world, the alignment between the board and the CEO is absolutely crucial, independent of exactly how it's structured. One of the most fundamental issues for people on boards today is to be able to judge what is truly in the interest of the shareholder. Some shareholders are getting very verbal and frankly don't have a track record to support their claims. So it's crucial for directors to understand what they are responsible for when it comes to value for the shareholder. Which shareholders are we really catering to? What's in the best interests of those shareholders?

I also believe that although the shareholder is the most important, you also have to take a look at the stakeholders. In our business, which is very much an infrastructure business, if you are not catering to the stakeholders in a good and positive way I believe that eventually there will be backlash.

We are now seeing examples of that backlash at Wal-Mart as well as at Home Depot. They are classic examples. Is it good for the shareholder to pay such little money to some employees? Yeah, maybe, on a short term basis. But if that then leads to a larger debate, and the right debate, with the larger stakeholder community, you have to be wise enough to balance off the different stakeholders. Or eventually it will come back to hurt shareholder value.


How do you balance those interests in Germany?
It's not that different from when you run any international company. We do not consider ourselves to be a German company. We consider ourselves to be an international company. We have stakeholders all around the world in 190-plus countries.


You have IG Metall, the metalworkers union, on your supervisory board. American CEOs really resist having organized labor at the board level. How do you make it work?
You have to distinguish between the union impact at the business level versus the boardroom level. My experience is that if you have the union at the business level, it can be very helpful in a turnaround situation. Those employee representatives are very well aware of what is needed and can help management push for change. That's my experience not only in Germany but also in other places.

When you talk about boardroom representation, in Germany we have this policy of codetermination, which is a 50- 50 representation on the supervisory board. The very fact that Germany, to my knowledge, is the only country where that exists speaks for itself. It has obviously not been one of the big export successes, and Germany is known as an export nation.


Does it create a contentious discussion at the supervisory board level?
It can go both ways.


So you're not recommending that American companies pursue that model?
I would think that you learn from history. (laughter)


Is it true that you and other European multinationals remain enthusiastic about investing in the U.S.?
That is very true. That enthusiasm is very much based on facts, which for us is that the U.S. today accounts for 35 percent of the world market but only about 22 percent of [Siemens'] sales. So you can see that there is a lot of breathing room where we can still grow. Secondly, there are a lot of industries we're in where the U.S. plays a lead role not only in terms of key customers but also innovation. We have about 70,000 employees in the U.S. and a little more than $20 billion in sales. Also interesting is that 11 of our businesses have their worldwide headquarters in the U.S. They are catering to the world market from here. We've invested $13 billion in the past eight to nine years, mainly in acquisitions. If you were to add the investments in our operations, the number would be even higher.


Are you concerned about the political backlash against allowing the Dubai group to buy American ports, or the drive by Congress to insert itself into the foreign investment approval process?
It's always a matter of concern to see the impacts of globalization and the reactions from governments in general. But frankly in this specific regard, we are very much a business-tobusiness company catering to different infrastructures. Even in the very difficult times after September 11, we have been able to win significant contracts. We bid together with Boeing for the first big airport security contract for the Transportation Security Administration and built it out in record time. This was at all of the U.S. airports in 2002. And here in New York, we have been awarded the build-out of the New York City subway infrastructure and other critical infrastructure projects.


Do you feel that you contribute to American innovation, or are you a competitor?
We contribute. Just look at the numbers. We spend about $1 billion a year on innovation in the U.S. In Princeton, we have one of our four corporate technology centers, with the others being in Germany, Asia and Russia. The one in Princeton is pretty significant because it has the worldwide competence center for pattern recognition. That is one of the substantial technologies going into all sorts of applications. It started out from the medical side. We all grew up with X-rays that were on film. I remember the first time I saw a threedimensional reconstruction of a CT image. Suddenly, you can look at it and say, "Wow, this is a kidney. Or a lung. Or a beating heart." Bringing those images together is what this team does. They understand what the patterns are like and put them together. They applied that know-how after September 11 in the security area. We provide security for the long shorefront at the NASA launch site at Cape Kennedy. There is the issue of distinguishing between frogmen coming out of the water and the tide coming in or some changes in the sun and clouds. We have been able to install an automatic system that can make the distinction.


Do you worry about the operating climate here, all the class action lawsuits, the requirements imposed by the Sarbanes-Oxley Act, and the rules imposed by the stock exchanges, for example?
Not really. We are a true international company. We have 470,000 people worldwide. Out of that, 160,000 are in Germany. We have 40,000 people in China. We're in 190 countries. That doesn't happen overnight. It only happens when there is something in the gene code of this company that is very international. We've always had a philosophy that we want to be ingrained in the local society. We need to have an understanding of local requirements, and we need to be able to cater to public and private infrastructures. We have to understand the public policies. That's why we've always worked very hard to weave ourselves into the society. I was very happy that when I left New York, where I was head of Siemens in North America, my successor was George Nolen, an American.

But you're listed on three stock exchanges, including the New York Stock Exchange. Haven't the reporting requirements imposed in recent years complicated your life?
I think it has complicated everyone's life. The amount of bureaucracy that has come along with that has been applied in a very undifferentiated way to companies large and small. That has certainly added an additional cost.

We know there are always black sheep. The question is, do you want to establish a principle in which you say, "We assume from the start that everyone is a black sheep and therefore everyone has to be treated like one?" Or do you want to have a system where you can go very heavily after the black sheep but also have a climate in which 90 or 95 percent of companies that are behaving are not getting overburdened by bureaucracy?


Does this climate affect your opinion about whether you should invest in the U.S. or, say, China?
We're a long-term investor. It is not like we are heavily influenced by short-term hiccups. The fundamentals for the U.S. are very strong. Even if Asia continues to grow at a doubledigit pace, the U.S. will continue to be our most important country for many years. That is also a reflection of the areas that are strong in the U.S.

Look at health care. We just made two large acquisitions, one in the area of in-vitro diagnostics and another in molecular diagnostics. Those areas are defining part of the future of health care and it's happening in the U.S. We want to be where the action is. That's why we spent $5.3 billion and almost $1.9 billion to acquire those companies. Those worldwide businesses will be headquartered in the U.S.


But U.S. CEOs complain about the business environment. Can you envision that it would ever affect your investment decisions?
Yes. It absolutely does play a role in decisions, but not if it's a short-term thing, almost like a fashion. If we were to foresee that in China the issue of accepting intellectual property rights is not getting resolved, this would be very prohibitive to continue investing in the build-out of R&D there. Fortunately, we do see a shift in that regard, and I am now very confident that intellectual property rights for companies such as ours will be accepted. It's partly because the new Chinese five-year program calls for innovation in a number of industries. Suddenly, the Chinese have a very strong interest in protecting their own patents on an international basis.

There are some core points they are not taking care of, such as the legal system. If the legal system is flawed, this is prohibitive for investments. But we are far away in the U.S. from a situation like that.


What else attracts you to this market?
As an immigrant country, it attracted the best and the brightest. Therefore, it has been able to maintain an extremely well-educated and highly motivated work force, which is critical for us because we always want to have an edge in innovation.


You've been leading a charge in Germany to persuade companies to become more competitive. Are you winning that battle?
Yes, it's very clear. You cannot have this debate on a national level. You have to bring it down to a level that is relevant to each individual. We have been having conversations with a lot of our employees at the different sites. Whom are we competing against? Who are the competitors? What are they doing? How do they operate? What do we have to do to stay competitive? Interestingly, people say, "Okay, if there is an option for me to increase my work hours to 40 hours without compensation, if that makes us a very competitive site again and if that then allows us to grow into new markets, I want to do this." If you look at our 160,000-person work force in Germany, about 80,000 of those are under union contract. I would say the contractual conditions have changed for almost all of them over the past three years.

We've done a lot of things including establishing retraining units where you have about 15 to 18 months of retraining so that you can find a new position, inside the company or outside the company. This has worked magically well. The rate of people being retrained and then going into new jobs is fabulous. This starts the kind of dynamics that are normal in an open society, which Germany in my view always was.


The prevailing view in the U.S. is that the German model is rigid. Is that fair?
I think it is fundamentally changing. I can only give you examples, like the labor contracts. Many [union leaders] have a very good understanding of the international competitive environment. They are open for discussion, saying, "Let's prepare for it. Let's change now so we don't have to get to a point where we have to lay off 10 percent. Let's try to achieve new flexibility." The creativity has increased. I'm very happy with this.

Reproduced with permission from Directorship Services LLC (c) 2006

Posted 12/1/06

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Breaking the Short-Term Cycle:

“Short-Termism,” Its Threats,
and What Can Be Done to Reform It

To download as .pdf

Beginning in September 2005 the CFA Centre for Financial Market Integrity, an international non-profit that focuses on ethics, excellence and education in the investment profession, and the Business Roundtable Institute for Corporate Ethics, an independent, non-profit research, education, and outreach organization,  co-sponsored a “Symposium Series on Short-Termism” to address the issue of “short-termism”— corporate and investment decision-making based on short-term earnings expectations as opposed to long-term value creation. The pressure to constantly increase short-term earnings has been cited by many business ethics and governance experts as a major factor contributing to instances of corporate fraud and ethical lapses. The resulting report from the symposia, “Breaking the Short Term Cycle,” describes the “short-termism” phenomenon, how it affects corporate ethics, and what can be done to reform it.

Note from the Editors: The report talks about “value” largely in terms of the accumulated worth of a company, rather than its ethical and integrity perspectives. It argues that the long-term value to shareholders of a company is likely to be greater when companies are less driven by short-term demands to publish quarterly results, provide quarterly income forecasts and so forth. These are the main issues of the report, which can be found at www.corporate-ethics.org.

At the same time, however, the authors of the study argue that taking a long-term perspective and setting aside the short-termism demands on so many companies, can have benefits for corporate governance, transparency and the ethics of a corporation. Below here we highlight the recommendations from this report that focus on these particular issues:

Breaking the Short-Term Cycle

Discussion and Recommendations on How Corporate Leaders, Asset Managers, Investors, and Analysts Can Refocus on Long-Term Value

Proceedings of the CFA Centre for Financial Market Integrity and the Business Roundtable Institute for Corporate Ethics Symposium Series on Short-Termism

Beginning in September 2005, the CFA Centre for Financial Market Integrity and the Business Roundtable Institute for Corporate Ethics co-sponsored a “Symposium Series on Short-Termism.” The purpose of these symposia was to address the issue of “short-termism”— corporate and investment decision-making based on short-term earnings expectations versus long-term value creation for all stakeholders — from a unique cross - group perspective.

The insights of our symposia participants (“the Panel”)—thought leaders from the corporate issuer, analyst, asset and hedge fund manager, institutional investor, and individual investor communities—confirm what the academic research suggests: namely, that the obsession with short-term results by investors, asset management firms, and corporate managers collectively leads to the unintended consequences of destroying long-term value, decreasing market efficiency, reducing investment returns, and impeding efforts to strengthen corporate governance….

In 2003, former U.S. Securities and Exchange Commission (SEC) Chairman William H. Donaldson called upon business leaders at a corporate governance forum “[to] manage the business for long-term results and to get away from the attitude that you’re managing the business out of a straight jacket that has been put upon you to create earnings per share on a regular basis.” He further encouraged these leaders to “present to investors exactly how you are going to manage that business.” (1) Expanding his concern at the 2005 CFA Institute annual conference, Donaldson cited “short-termism” as a critical issue facing the financial industry.

Similar concern is noted by corporate executives. In research conducted by the Business Roundtable Institute for Corporate Ethics, chief executive officers (CEOs) at many of the largest U.S. corporations were asked to identify the most pressing ethics issues facing the business community. “Effective company management in the context of today’s short-term investor expectations” was among the most cited concerns. (2)

In a recent survey of more than 400 financial executives, 80 percent of the respondents indicated that they would decrease discretionary spending on such areas as research and development, advertising, maintenance, and hiring in order to meet short-term earnings targets and more than 50 percent said they would delay new projects, even if it meant sacrifices in value creation. (3) These results demonstrate that short-termism is a larger issue than companies simply using accounting actions to meet quarterly earnings expectations. These are real actions—asset sales, cuts in research and development, and forgone strategic investments— that corporate managers use to hit “the quarterly earnings number.” Although the creation of long-term company value is widely accepted as management’s primary responsibility, this research suggests that managing predominantly for short-term earnings expectations often impairs a manager’s ability to deliver such value to shareowners.

These collective concerns mirror the views of the Panel gathered for the symposium series on short termism. The Panel agrees that an obsession with meeting short-term expectations of varying constituencies too often hinders corporate managers and all types of investors from focusing on long-term value creation. The causes of this short-term fixation are multifaceted, which necessitates reforms that involve many stakeholders, including those who participated in the symposium (corporate issuers, analysts, asset managers, shareowners, institutional investors, regulators, and media representatives).

To be sure, the introduction of new information that is material to a company’s health demands that investors and other market participants respond quickly. Such short-term actions actually promote market efficiency. The short-termism issue addressed in this paper, however, focuses on instances in which long-term investment decisions are made on the basis of short-term information, the most prominent of which is the “hit or miss” of quarterly earnings guidance. The Panel believes that where long-term planning and investment is called for, short-term information should factor into decision making primarily in the context of supporting such long-term strategy.

Short-termism refers to the excessive focus of some corporate leaders, investors, and analysts on short-term, quarterly earnings and a lack of attention to the strategy, fundamentals, and conventional approaches to long-term value creation. An excessive short-term focus combined with insufficient regard for long-term strategy can tip the balance in value-destructive ways for market participants, undermine the market’s credibility, and discourage long-term value creation and investment. Such short-term strategies are often based on accounting-driven metrics that are not fully reflective of the complexities of corporate management and investment.

From the “RECOMMENDATIONS”

The Panel encourages corporate leaders, asset managers, institutional investors, and analysts to:…..

Earnings Guidance

1. End the practice of providing quarterly earnings guidance.

2. However, companies with strategic needs for providing earnings guidance should adopt guidance practices that incorporate a consistent format, range estimates, and appropriate metrics that reflect overall long-term goals and strategy.

3. Support corporate transitions to higher-quality, long-term, fundamental guidance practices, which will also allow highly skilled analysts to differentiate themselves and the value they provide for their clients.

Communications and Transparency

1. Encourage companies to provide more meaningful, and potentially more frequent, communications about strategy and long-term vision, including more transparent financial reporting that reflects a company’s operations.

2. Encourage greater use of plain language communications instead of the current communications dominated by accounting and legal language.

3. Endorse the use of corporate long-term investment statements to shareowners that will clearly explain—beyond the requirements that are now an accepted practice—the company’s operating model.

4. Improve the integration of the investor relations and legal functions for all corporate disclosure processes in order to alleviate the current bifurcated communications that confuse, rather than inform, investors and analysts.

5. Encourage institutional investors to make long-term investment statements to their beneficiaries similar to the statement the Panel is asking companies to make to their shareowners.

Education

1. Encourage widespread corporate participation in ongoing dialogues with asset managers and other financial market leaders to better understand how their companies are valued in the marketplace.

2. Educate institutional investors and their advisors (e.g., consultants, trustees) on the issue of short-termism and their long-term fiduciary duties to their constituents.

3. Support education initiatives for individual investors in order to encourage a focus on long-term value creation.

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For the full report visit the Business Rountable Institute for Corporate Ethics’ Website at http://www.corporate-ethics.org

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Endnotes:

1. “The New Environment in Corporate Governance: Taking Stock and Looking Ahead,” Business Roundtable Forum on Corporate Governance (10 September 2003).
2. “Mapping the Terrain” survey, Business Roundtable Institute for Corporate Ethics (2004). At www.corporate-ethics.org.
3. John R. Graham, Campbell R. Harvey, and Shivaram Rajgopal, “The Economic Implications of Corporate Financial Reporting,” Journal of Accounting and Economics, vol., 40 (2005): 3–73.
4. John C. Bogle, The Battle for the Soul of Capitalism (New Haven, CT: Yale University Press, 2005): 43.
5. McKinsey and Company, The McKinsey Quarterly (March 2006). Web exclusive. At www. mckinseyquarterly.com.

Posted 11/3/06

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The Center for Environmental Law and Policy at Yale University recently released a report by Professor Robert Repetto making the case for rapid adoption of best practice in internal oversight of corporate lobbying activities. It identifies best practice as oversight by the board of directors of lobbying activities, expenditures and positions on public policy issues with broad societal impacts.

In an article written for EthicsWorld, Professor Repetto summarizes the key points from his paper and discusses their implications for corporate governance reform:

Some companies, including GE, Alcoa, AMD and Morgan Stanley among others, already have such oversight procedures in place. However, this vanguard is still a small minority of the companies that undertake significant lobbying. Recent surveys show that in 2005 only 13.6 percent of companies in the S&P 500 have a standing board committee on public policy or corporate social responsibility, a percentage that has actually been declining. Only a small percentage of companies have even explicit policies on lobbying, let alone board oversight.

Despite this lack of oversight at the board level, corporate lobbying continues to grow at a rapid rate. Lobbying expenditures are doubling every decade and in the last decade the number of registered lobbyists in Washington, D.C. grew from about 10,000 to about 25,000. Much of this activity is carried out by lobbying firms and industry associations on behalf of the company. This in itself can lead to outcomes inconsistent with the company’s interests. For example, many large companies, including BellSouth, Altria and Union Pacific contributed generously to the political action committee “Americans for a Republican Majority”, which has been centrally involved in the scandals and lawsuits involving Tom DeLay and Jack Abramoff.

Businesses justify their lobbying activities as essential to strategic management of their companies, in as much as business outcomes can be greatly influenced by government decisions. Those companies most dependent on government purchases, regulation or subsidies are most likely to lobby heavily. It is, of course, entirely legitimate for the corporate perspective on public policy issues to be presented to government policy makers. Businesses are by no means the only interests that lobby.

Board oversight is required in part just because lobbying for particular outcomes on public policy issues is often important for the overall success of a company’s business strategy. Therefore, a director’s duty of care requires him or her to be informed on this, as on any other, significant aspect of business strategy and to provide oversight. Board members cannot take refuge in the “prudent business judgment” rule if they have failed to inform themselves. There is always the risk common to all business plans, that the lobbying strategy may be ill-conceived and will prove unsuccessful. For example, American automobile manufacturers have long lobbied against tighter CAFE standards while making most of their profits on sales of SUVs and light trucks, a strategy that worked while gas prices were low but is proving disastrous after gas prices rose. Would a less defensive posture that did not cede the advantage on energy efficient engines to the Japanese have been wiser?

Similarly, many energy companies and electric utilities have been lobbying against mandatory controls over greenhouse gas emissions, even though economic studies and actual European experience have shown that such controls can be designed in ways that actually lead to higher profits in those industries. Would a proactive approach that guaranteed the energy companies a role in the design of business-friendly climate policies be wiser? Aren’t these issues that deserve board consideration?

Lobbying on public policy issues affects shareholders directly, since it can lead to reputational and other losses and be used to reinforce unsuccessful business strategies. Lobbying can also affect shareholders indirectly because a company’s shareholders are also owners of other assets, and may be employees, consumers, taxpayers and citizens.

• Large pharmaceutical companies lobbied to prevent the federal government from negotiating drug prices, successfully defending their profits but raising costs to shareholders who are also consumers of their medicines.
  
• Enron actively lobbied against wholesale electricity price caps, regulation of energy derivative trading by the Commodities Futures Trading Commission, and intervention by the Federal Electricity Trading Commission while it was designing and implementing various schemes (Fat Boy, Get Shorty, Death Star, etc.) to manipulate west coast electricity markets causing billions in losses to California consumers, businesses and taxpayers.
  
•  Tobacco companies lobbied against higher cigarette taxes, for continued price supports to tobacco farmers, and to scuttle settlements with state governments, though tobacco use results in excess mortality in the hundreds of thousands, excess morbidity and higher health costs.
  
• Energy companies have lobbied against carbon emission reductions through climate change is increasing risks of losses from storms, flooding, seasonal droughts, infectious diseases and other impacts. 
  
  

Directors in leading companies do take into consideration these broader interests of shareholders and other constituencies when developing their positions on public policy issues. For such reasons, Jeff Immelt, CEO of General Electric, believes “… to be a great company, you have to be a good company” and Lee Scott, CEO of Walmart, has said “For use there is virtually no distinction between being a responsible citizen and a successful business … they are one and the same for Walmart today.” Best practice in corporate governance thus requires board oversight of lobbying activities on public policy issues of broad societal significance. 

For the full report, "Best Practice in Internal Oversight of Lobbying Practice" follow this link.

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Private Enterprise, Public Trust
The State of Corporate America
After Sarbanes-Oxley

A Report by the Committee for Economic Development (CED)

This landmark report underscores that the Enron collapse and many of the later scandals combined to erode public confidence in America's publicly listed corporations.  The restoration of confidence will take time, but it will also require significant reforms in the ways in which corporations are governed. The prime responsibility for action and for change rests with the Board of Directors, according to this new study.

EthicsWorld Publisher Frank Vogl is a CED Trustee and served as a member of the CED working group that developed this new report. He notes: "We found, above all, that two critical issues need to come still more fully into the foreground if shareholders and the public are to have greater confidence in the ethical management of companies: First, more visible and explicit accountability by the Board of Directors to shareholders, with particular reference to the Audit Committee's work in the financial areas. Second, transparency with particular emphasis on every aspect of executive compensation."

Executive Summary

The highly visible accounting scandals that surrounded the collapse of Enron, WorldCom and several other major companies—together with the revelation of fraud and other acts of malfeasance by corporate executives— have aroused public outrage, called into question the values and ethics of business leaders, and undermined the public’s confidence in public companies. CED, as a public-policy organization in which current and retired business leaders play a prominent role, is concerned about the reality, as well as the appearance, of corporate impropriety.

We are unwavering advocates for the free market system, but we are just as firm in our belief that businesses and their leaders must earn the public’s trust. Perceptions that firms flout rules, behave unethically, and use deceptive business processes weaken confidence in, and support for, the free enterprise system. Executive compensation that is untethered to economic value and violates perceptions of fairness leads to mistrust and the prospect of a stifling regulatory backlash. The ethical failing of a small number of corporate leaders is infectious: it undermines the ethical standards of their own firms and affects the behavior of others and, therefore, must be cured.

This policy statement addresses governmental and corporate policies that affect the behavior of publicly traded companies, as well as the confidence of investors in them. We acknowledge at the outset that no laws or policies will ever be sufficient to end all corporate misbehavior (or, for that matter, misbehavior in any segment of public life). We are confident, however, that truly independent and inquisitive boards of directors will provide the best safeguard against corporate wrongdoing.

We observe and conclude the following:

(1) Audit Committees Must be Autonomous and Vigorous

In order to accurately present a company’s position, the board of directors must have access to all pertinent data. This will occur only if a board’s audit committee is competent, independent, and establishes effective control over both the internal auditors and the independent outside auditors. The relationship between the audit committee of the board and the outside and internal auditors is crucial. The audit committee should exercise the same tone of control over the internal auditor as it does over the external auditor, extending to decisions of hiring, firing, and compensation.

(2) Financial Information is Inherently Judgmental

Financial statements would be more useful if they were governed by fewer rules and displayed more of the judgment that lies behind estimated numbers. Stock analysts, the investing public, and regulators must recognize the inherently judgmental character of accounting statements and financial information. Ranges of values rather than precise numbers should be explained and understood as such. In addition, financial statements should be supplemented with non-financial
indicators of value.

(3) Give Sarbanes-Oxley a Chance to Work

CED sees room to tailor the requirements imposed by Section 404 of Sarbanes-Oxley within the existing statute, and endorses the Public Company Accounting Oversight Board (PCAOB) and Securities and Exchange Commission (SEC) implementation guidance based on their evaluation of the first-year experience. The guidance, issued simultaneously by the two agencies in May 2005, should lower the costs and increase the value of Section 404 compliance. Moreover, CED does not recommend a broad exemption to Sarbanes-Oxley requirements for small-capitalization companies, but nevertheless supports the objective of mitigating the costs to smaller companies.

(4) Excessive Executive Compensation Can be Tamed by the Compensation Committee

In CED’s view, the disparity of income between top corporate executives and average employees is a cause for serious concern. We are concerned that the differentials that exist today too often reflect neither market conditions nor individual performance. The procedure for determining executive compensation has been broken at far too many of our larger corporations, and we believe that the solution to excessive executive compensation must be regarded as a matter of process and disclosure.

To that end, we make the following recommendations:

• Compensation committees should adopt measurable, specific, and genuinely challenging goals for the performance of their businesses, and judge management by them.

• The compensation process must be run by compensation committees composed of independent directors. And compensation consultants, when used, must be entirely independent of management. The compensation committee should have direct authority over all terms of any management contract, including all forms of compensation.

• Management should have a substantial equity interest in their company.

• Management should make a full, timely, and transparent disclosure of its compensation to shareholders.

• Choices of forms of compensation should promote the long-term value of the firm, rather than exploit favorable accounting or tax treatment.

• Severance compensation, like all other forms of executive compensation, should be reviewed carefully against criteria set by the compensation committee of the board, and the board should publicly provide full details of awards and explain publicly to shareholders the reasoning behind such awards.

• Companies should have the right to recapture top executive bonuses if financial results by which they were justified turn out not to have been achieved when accounts are restated.

(5) Directors Must be Selected and Appraised by Independent Nominating Committees

A paradox of corporate stewardship is that, despite the principle that directors represent shareholders in the selection and retention of management, historically most directors have been selected by management. In our view, the best approach to building high-quality boards is to assign to truly independent nominating committees the responsibility for recommending new board candidates and for evaluating the performance of existing board members. The nominating committee should also have the responsibility of recommending committee assignments.

Conclusions

Relations between corporations and investors have suffered wrenching change in the last five years, from both corporate misdeeds and the legislative reaction to them. For all of the damage and pain, the potential exists for ultimate benefit to all parties, as better and more transparent information breeds renewed investor confidence and higher standards of behavior and openness.

In this statement, CED has recommended some changes in practice to hasten this beneficial adjustment. However, we would view such proposed change as modest, and within the scope of the recent revisions in corporate governance practices. CED believes that the wisest course now would be patience, to allow these new practices and institutions to be learned and understood, and to demonstrate their merit.

Committee for Economic Development

CED is a non-profit, non-partisan public policy research organization led by 200 senior corporate executives and university leaders. The complete policy statement, as well as other CED publications, is available online at www.ced.org

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Integrating Ethics At The Core
by Vivek Wadhwa
Business Week November 8, 2005

In his article Mr. Wadhwa writes: " The fact is, venture capitalists are usually motivated by quick, short-term profits. Management typically wants high salaries, perks, and more stock options. Independent directors are needed to protect the interests of all shareholders, because ultimately, it's the board that needs to enforce the corporation's ethical standards."

He adds: "The bottom line is that there are no shortcuts to creating an ethical organization. The challenges are different at every stage of the game, and it only gets harder. But if you do everything right, you will have laid the foundation for a sustainable and successful business." Mr. Wadhwa is the founder of two software companies, is an Executive-in-Residence/Adjunct Professor at Duke University. He is also the co-founder of TiE Carolinas, a networking and mentoring group.

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