Corporate America's Biggest Problem?

One year after the government bailed out Wall Street, Goldman Sachs (NYSE: GS  ) and JPMorgan Chase (NYSE: JPM  ) are awarding record billions in bonuses. Clearly, compensation practices are just as out of line now as they were before the financial crisis. But compensation is just one part of the larger issue of corporate governance weighing on companies across America.

According to Nell Minow, editor and co-founder of The Corporate Library, a research firm that focuses on corporate governance, agency costs and conflicts of interest are the inherent problems in corporate governance today.

"If you're going to have a large, complex organization, and you're going to take capital from people who are not going to be in the boardroom all the time, what can we do to ensure those directors are as vitally concerned with the long-term success of the organization? That's what corporate governance is all about," Minow said on a recent visit to Motley Fool headquarters.

The Corporate Library rates 3,500 firms with letter grades -- and out of those 3,500, only four have been awarded an A. In general, Minow argues that founder-run firms are a great solution to the "agency cost" problem, in which shareholders' interests are not aligned with those of management. In a founder-run company, the CEO still has most of his or her net worth in the company; thus, for both personal and financial reasons, he or she remains dedicated to making sure the company succeeds.

If more companies were like hers, Minow says, things would be better. All of the shareholders in The Corporate Library are on the company’s board. "It's our money that's at risk, and we care very much how it all comes out," she says. "So we're focused on making sure it all works."

Just one wish
So if Minow had a magic wand, what’s the first thing she would change? She says her first wish would be for a change in Delaware state law. Many companies are incorporated in Delaware, and under the state’s current law, any member of a company’s board who gets at least one vote -- even if it's their own -- is allowed to remain. According to Minow, more than 90 people are currently serving as members of a board even though a majority of the shareholders voted for them to go. Minow argues that if shareholders cannot replace directors who get it wrong, the problem will remain.

Revamping financial reporting
There are two areas of financial reporting Minow thinks should be rectified. The first: When the SEC was originally drawing up rules for the disclosure of executive compensation information, it was going to require companies to provide data on their top five highest-paid employees. However, companies were not in favor of that. For instance, people working on the trading desk didn't want the public to know what they were getting paid. Companies were able to coax the SEC into requiring information on the top five officers of the company instead. "So we get a lot of information about what the CFO makes, and not so much about how the company is managing its overall incentives," says Minow.

Minow says she would like to see aggregate information about anyone in a company who gets more than 50% of their income in the form of a bonus -- both the amount of compensation, and the criteria for awarding it.

Second, Minow says we are using 19th-century accounting principles for 21st-century companies. She believes accounting needs to be changed in a very fundamental way -- so that it's more about risk and intellectual and human capital, and less about hard assets. "We get a lot of information about the desks, the chairs and the real property, and not that much information about the people, education, relationships, and ability," she said.

Corporate governance and society
Minow says the failure of corporate governance can produce a recession like the one we've just experienced -- because corporate governance is about assessing and managing risk. Failure to do that, according to Minow, means that risk gets externalized onto the taxpayers and the rest of society.

I had the opportunity to interview Yale finance and economic professor Robert Shiller recently, and he echoed Minow's sentiments. He told me that the latest executive compensation issue exemplifies the widening gap in economic inequality in this country, which he says is bad for the future of America.

In the wake of extravagant bonuses from Wall Street firms, Shiller says the angry populist chorus is growing louder, and it's starting to lead to ugly resentment. To that end, Shiller says it's time for the nation to think seriously about restraining any further increases in economic inequality.

For related Foolishness:

Fool contributor Jennifer Schonberger does not own shares of any of the companies mentioned in this article. The Motley Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (15)

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  • Report this Comment On November 17, 2009, at 8:46 PM, jm7700229 wrote:

    Interesting article, but I wonder about Minow's conclusions.

    1. Are we more interested in how much money the employees are making, or how much money the shareholders are making? If a company is overpaying its people, it won't remain competitive, will it? And if it is competitive, why would I care who makes what.

    2. I'm not sure that Minow understands financial statements. They aren't much about desks and chairs, but they are about money. Do you want your CPAs auditing your human resources, your lawyers auditing abilities? Who is qualified to audit relationships? Again, I don't care about the education of the people on the trading desk, I care about whether they are making money for me.

  • Report this Comment On November 17, 2009, at 10:51 PM, xetn wrote:

    Good points raised by jm7700229.

    It is interesting to me to hear so many "Fools" espousing more and greater regulation on business by government. You would think that the ideal of maximizing profits and therefore stockholder value would be the main concerns of folks intent on making the most of their investment dollars.

    It might just surprise everyone of the existing onus on business by government intervention already on the books. The following link:

    http://mwhodges.home.att.net/regulation_a.htm

    projects that, as of March 2005, that compliance costs $1.4 trillion. Thus it does not include any new regs. According to the study it costs every man, woman and child over $4600 for this burden.

    Given this level of expense, and it is much greater percentage wise for smaller firms) why there has been a massive exodus of jobs out of the US as well as a fairly large number of actual companies. I believe it fair to say, that it has also prevented a lot of foreign companies from move here.

    At any event, it seems to me that the best regulation would be personal responsibility to insure that you get the best for your money, regardless of whether it is buying a new car, house or whatever. There are many sources of information (Fool for example in investing) where you can verify claims of quality and value. Consumer Reports, UL and others come to mind. Why does everyone presume that government will act in your best interests when it is a fact that they never do. The government only acts in its own interests.

  • Report this Comment On November 17, 2009, at 10:55 PM, MikesMoneyTalk wrote:

    This is a moral crisis not a financial crisis. Michael Jon Byers Lubbock Texas

  • Report this Comment On November 18, 2009, at 11:53 AM, corpgov wrote:

    The best regulations are those that facilitate the ability of interested parties to hold people accountable. We can't afford to put cops and auditors in every company. However, we can afford to give shareowners the tools they need to ensure against unreasonable risk.

    Proxy access, allowing shareowners to place their nominees on the corporate ballot, is just such a measure. The Business Roundtable (made up solely of 160 corporate CEOs, our employees) and its dependents are lobbying the SEC heavily to have proxy access be only a triennial event and also allow corporations to opt out of the requirement altogether. (http://blogs.law.harvard.edu/corpgov/2009/11/12/proxy-access...

    I urge Motley Fool readers to go to the SEC site at http://www.sec.gov/cgi-bin/ruling-comments?ruling=s71009&...

    Let them know you don't want the proposed proxy access rules watered down.

  • Report this Comment On November 18, 2009, at 5:12 PM, MaryAdamsICA wrote:

    To Ms. Monow's point about outdated accounting, here are a few data points:

    In 2007, 70% of the average acquisition was intangible (not on the balance sheet)

    In 2007, US corporations invested an estimated $1.6 trillion in intangibles versus $1.2 trillion in tangible capital expenditures (a 60/40 split)

    This kind of data is also reflected in the gap between total corporate value per the stock market and the net book value of the average company.

    This data reflects the dramatic shift to the knowledge economy that has already occurred. The best accounting can do today is create goodwill when there is an acquisition http://www.i-capitaladvisors.com/2009/11/04/goodwill-is-a-me...

    All the stakeholders of our financial system should be concerned that at least 50% of the money spent and the value created in today's economy is missing from financial statements. When the balance sheet is meaningless, then the only source of information is the income statement--no wonder we are locked in a short-term mindset.

  • Report this Comment On November 19, 2009, at 12:08 AM, PsycheDaddy wrote:

    Like all businesses, the owner is always working harder than employees. When the owner is gone, things go amuk. Bad decision and greed being driven against owners interest will hurt profits. Employees will think of more ways to make a buck from the inside. It doesn't matter if your a moonlighter, commissioned, bonused, or a thief. When at work, people think of money. They say loyalty left corporate America a long time ago.

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