The boards of directors of Citigroup, Merrill Lynch, and other financial institutions may have contributed to their massive subprime mortgage–related write-offs by creating compensation packages for their chief executive officers that didn’t punish them for failure, says Nell Minow, editor-in-chief of The Corporate Library, an independent research firm that rates governance practices. In fact, this approach to their compensation encouraged them to take undue risks, she says. These CEOs were guaranteed outsized exit and separation packages, regardless of how they or their firms performed. And now that many of them have been shown the door, there is little hope that shareholders or directors could “claw back” any of that pay, Minow says. One important solution, she argues, is for more companies to adopt rules specifying that to be elected, directors must receive a majority of shareholder votes cast, rather than a plurality as is typically the case now (indeed, currently even if a large number of shareholders abstain, a director can be elected with just a few affirming votes). This would raise the prospect that directors could more easily be ousted by dissatisfied shareholders if they grant overly generous compensation packages. William J. Holstein, a contributor to strategy+business, talked to Minow in late January 2008 about her attempts to refashion the relationship between boards, shareholders, and top executives.
S+B: In what ways were the boards responsible for the current debacle in the financial-services sector?
MINOW: There were a couple of precipitating factors. One is that the boards weren’t paying enough attention. They weren’t asking the right questions. And the other is that they were creating executive compensation plans that had the effect of pouring gas on the fire.
You can see how it worked by looking at it in hindsight. All of the CEOs who failed got paid very well. Therefore, the pay plans had very perverse incentives. Yes, the CEOs did receive incentive compensation, but incentive to do what? If the incentive was to essentially offload risks — which is what happened, because the CEOs were pushing much of the risk off to shareholders — then this is what you get.
S+B: It seems that the vast majority of U.S. companies have more independent boards and more effective governance than they used to. So what went wrong in the financial sector?
MINOW: Generally speaking, yes, there have been tremendous improvements. Boards are doing a much better job than they did a few years ago. They’re providing much more diligent oversight. But in the financial-services sector, I don’t think there has been much improvement. In the very first set of corporate governance grades that we at The Corporate Library issued in 2003, Citigroup was dead last, even though Institutional Shareholder Services (another governance ranking agency) was giving them top marks. On paper, Citigroup looked like it had wonderful corporate governance policies. But on the two issues we thought were most important, the board failed abysmally. One was pay for performance — their approach was awful — and the other was how the board responded to the analyst scandal (in which Wall Street firms were found to have falsified positive research about companies in an effort to win investment banking business). Citigroup was the only company in which the CEO was personally involved in one of the most outrageous conflicts of interest and one of the most outrageous breaches of ethics of that period: the incident involving analyst Jack Grubman. [According to investigators, in 2000, Citigroup CEO Sanford Weill asked Grubman, the company’s top telecommunications analyst, to raise his rating of AT&T; after Grubman complied, Citigroup won a US$45 million assignment to help underwrite a share sale in AT&T’s wireless unit.] As a result of his personal involvement, Weill was restricted in his ability to meet with his analysts without an attorney present. And yet the board did not impose any sanctions on him. That is the definition of a bad board. They didn’t know how to respond when the CEO failed.