All Aboard: Costco

Editor's note: A previous version of this article contained incorrect information about Costco board member Sue Decker. The Fool regrets the error.

We usually hear about a board of directors only when its members are up to no good. Proxy battles, compensation scandals, and takeover proposals bring these stewards of corporate governance into the spotlight, but when they're simply doing their jobs, nobody pays any attention. I'm here to highlight a few boards of directors, good or bad, to give you a more detailed picture of the companies they shepherd -- no scandals necessary.

This week, we're looking at Seattle-based warehouse retailer Costco Wholesale (Nasdaq: COST  ) , a Motley Fool Stock Advisor pick with a top-notch reputation for corporate citizenship.

Meet the board
First off, let's set the ground rules. The Costco Board of Directors doesn't have a fixed size, nor any upper or lower size limits. Instead, the board can vote on the number of seats at any time. There are currently 13 members, nine of whom are external. That fulfills the stock-exchange and SEC requirements for a majority of independent directors, and then some.

Chairman Jeff Brotman counts as an internal director, having co-founded the company back in 1976. This is his only job, as far as I can tell -- the bylaws don't require a separation between the CEO and chairman roles, but they do allow it, and that's what Costco has in place today. Brotman doesn't sit on any other corporate board, either.

Affable CEO and President Jim Sinegal is the other co-founder, and another internal director fully dedicated to Costco, the whole Costco, and nothing but Costco. He does serve on the board of trustees of Seattle University, but he holds no other corporate positions.

CFO Richard Galanti and COO Richard DiCerchio round out the allotment of internal directors. It's the first time in this series I've seen the top three executives serving on the board. All of them have been with the company since at least 1984, and they've stayed true to Costco all these years, with no distracting outside directorship positions or other significant side gigs. That kind of experience and dedication should be quite valuable to the board as a whole.

But that doesn't mean that this board lacks industry connections. You'll see some serious firepower among the outside directors I'm about to detail.

Bring on the big guns
For starters, there's the chairman of Costco's audit committee -- Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) Charlie Munger. He's Warren Buffett's second-in-command, and a legendary investor and advisor in his own right. I can think of very few people better suited to double-check the company's financials and procedures.

Then there's William Gates Sr. -- not the brain behind Microsoft (Nasdaq: MSFT  ) , but rather the father of that Bill Gates. The Gates family hails from the Seattle area, just a stone's throw from Costco headquarters. Gates Sr. serves as chairman of the nominating and governance committee, which recommends new director candidates, oversees the board's performance and adherence to rules and guidelines, and reviews corporate governance and ethical conduct issues.

With all these experienced board members, why didn't Costco make the top 100 corporate citizens list I've mentioned before? And why does its Corporate Governance Quotient ranks in the bottom 3% of all S&P 500 companies, according to Yahoo! Finance?

Costco gets much respect for its frugal executive pay scales, great employee relations, and involvement in the community. But like practically every major company, Costco is always fighting a handful of class action lawsuits over real or imagined infractions. The current list includes overtime compensation issues, land-development ethics, and charges of gender-based promotion policies. But again, this is pretty standard procedure - AMD, with its stellar citizenship ranking, is under antitrust investigation and a grand jury subpoena, for example.

In addition, the company got caught in options granting improprieties, though the SEC investigation found no evidence of intentional wrongdoing. Still, Costco took a $47 million tax charge to set the record straight again. (Read more about the company's classy response to the snafu.) That should probably count as a strike against Munger more than Gates.

In total, I'm not entirely sure why Costco rates so poorly in these statistics, since the company appears to do well in nearly every evaluation category I could identify. More investigation may be needed here.

Back to the roll call. The youngest member of this board -- at 44 years old -- is Sue Decker, the longtime Yahoo! (Nasdaq: YHOO  ) CFO who stepped up to that company's President post last week. Many see her as the natural heir to the Yahoo! throne. Aside from her spots on Costco's corporate governance and nominating committees, Ms. Decker holds board seats at chip giant Intel (Nasdaq: INTC  ) and Berkshire Hathaway. Not a bad resume.

Perks and power
I didn't mention the compensation committee yet. That three-man group includes Munger, pediatric neurosurgeon Dr. Benjamin Carson, and Blackstone President Hamilton James, and it's tasked with setting compensation for board members and executives.

Internal directors don't get paid for their board services, since they have a regular salary for their executive duties anyway. Independent directors receive a $30,000 annual salary, plus $1,000 per board or committee meeting attended and reimbursement of associated travel costs. They will also get 3,000 restricted stock units every October, set to vest in thirds, and representing a value of about $171,000 per year at today's share prices.

The bylaws don't require directors to own stock, but they all do anyway. Not that it's hard to do, given the automatic options awards for their services, but still. The entire board as a whole owns about 2.4% of the voting rights through its Costco stock holdings.

As always, the board's strongest card may be its ability to hire, fire, and pay the executive staff. But while some companies rely on peer-group statistics to settle on appropriate pay levels, this compensation committee blithely states that "the Company's executive officers generally receive lower compensation than executive officers at [the selected peer group]," in line with the frugal corporate philosophy. In another decidedly Foolish twist, "the Committee believes that Mr. Sinegal and Mr. Brotman are underpaid. Accordingly, their compensation levels for fiscal 2006 are fair to the Company."

Some companies have poison pill provisions, golden parachute contracts for executives, and other anti-takeover measures in place. Costco has nothing of the sort besides three classes of directors, a structure ensuring that it would take at least two years for a hostile acquirer to gain more than half of the board seats.

Final Foolish thoughts
This is running a bit long, but there's just a lot to say about this particular board.

Costco's investor relations site leaves a bit to be desired. I had to go to secinfo.com to find a copy of the current bylaws, for example. Granted, that document hasn't seen any changes since the year 2000, when communicating with investors through the Web wasn't a given the way it is today, but still. These are the fundamentals, guys.

So there seems to be a bit of sloppy action on this board, as talented as its members may be. And these directors are generally getting long in the tooth -- three of them are more than 80 years old, and another two are over 70. There should be some turnover here in the next few years, then -- maybe some fresh blood is what the corporation needs. After all, there will still be plenty of gray-haired insider expertise among the other eight directors.

This exercise opened my eyes to some issues I didn't know about at the retailer. Costco, with its massively experienced financial experts on the board, wouldn't show up on my personal list of suspects for options troubles. But there it is anyway.

Is that enough to scare me away from the stock? Well, no. It's still innocent until proven guilty, and the options issue has been dealt with at a fairly small price for a company with more than $1 billion in annual net income. But it's all worth keeping in mind when weighing your next investment -- as is the tremendous collection of individuals in this elected body.

Fool on:

Costco, Berkshire Hathaway, and Yahoo! are all Motley Fool Stock Advisor picks. Berkshire is also a Motley Fool Inside Value recommendation, alongside Intel and Microsoft. Snag a couple of free 30-day trial passes to find out more about these clusters of brilliance.

Fool contributor Anders Bylund owns shares of AMD and Google, but holds no other position in any of the companies discussed here. You can check out Anders' holdings if you like, and Foolish disclosure always looks good on your resume.


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