This Practice Could Save Your Portfolio

Long-Term Capital Management. Enron. Worldcom. The 2008 financial crisis. Corporate scandals, frauds, massive mistakes, and capital destruction seem to happen over and over again, even when regulators attempt to step in and prevent the next disaster. One factor that's often overlooked or shrugged off could save the marketplace from such catastrophes: good corporate governance policies.

Solid corporate goverannce policies -- which, for many years, have been sorely lacking at many companies -- ensure that plenty of checks and balances exist in the relationship between three important constituents in the corporate realm: managements, boards of directors, and shareholders.

Most of our public companies' failures come about because of shoddy policies that let managements and boards run roughshod over everyone else's interests but their own. The importance of good governance simply cannot be dismissed any longer.

When leaders loot
Enron is one of the most well-known catastrophic corporate events. When all was said and done, investors lost $70 billion to the scandalous fraud; trustees and employees lost another $2 billion. After the accounting scandals and management lootings that came to light in 2001 and 2002, you would think lessons would have been learned. But memories are woefully short.

Today, there are still plenty of companies that appear to be run far more for the benefit of managers than anyone else. Chesapeake Energy (NYSE: CHK  ) is a timely example. For years, CEO Aubrey McClendon has been doing business as if the company were his own personal piggy bank, and Chesapeake's directors let it go on, rather than doing their job: pushing back to defend shareholder interests.

Carl Icahn recently took a stake in Chesapeake Energy, and large shareholders filed to become activists as the situation proved to be more and more outrageous. Now, four directors will resign and be replaced by independent directors. These are steps in the right direction after the board's halfhearted gestures before the shakeup, which included vows to cut directors' pay and no longer allow them to fly Chesapeake's corporate jet for personal business.

Chesapeake's new independent chairman Archie Dunham has been assigned the task of trying to keep McClendon reined in. We'll see how well this goes, given the company's long history of governance problems, worsened by the recent deterioration of its financial condition.

Failing grades, failing votes
Corporate governance research and ratings firm GMI Ratings tracks corporate governance constantly and assigns grades to companies according to their practices over the years. Although some earn good ratings, many others fail.

For instance, Navistar (NYSE: NAV  ) gets an environmental, social, and governance rating of "F" from GMI. Issues include CEO compensation that has consistently risen despite the company's underperformance, a recent fine from the Environmental Protection Agency, and the company's repeated need to restate its financials.

Despite Oracle's (Nasdaq: ORCL  ) recent supposed victory with quarterly results, GMI Ratings wasn't won over, giving it, too, an "F" rating. Oracle's corporate governance problems under well-paid CEO Larry Ellison include repeated executive team shakeups and the enthusiastic hiring of Mark Hurd, who left Hewlett-Packard (NYSE: HPQ  ) after a high-profile sexual harassment scandal.

Hewlett-Packard has been subject to plenty of heat regarding its policies as well. The fact that its board allowed Hurd to simply resign and therefore remain entitled to a massive golden parachute is just the tip of the iceberg when it comes to governance missteps over the years.

When corporate managements and boards seem to believe all ethical violations are forgiven for friends or those of similar stature, that they are somehow above the law and free to play "fast and loose" with accounting, or that CEOs should always be well-paid regardless of their actual performance, shareholders had best steer clear or push back with their proxy votes.

A majority of Citigroup (NYSE: C  ) shareholders voted down the company's compensation policy this year. This and other recent events show that more investors are getting the picture: as partial owners, investors have a say.

Bringing ownership back to investing
For too long, investors have been brainwashed into thinking that whatever corporations' management and boards do is somehow not investors' business, and if they didn't like managements that put their interests first, investors should simply sell. Even worse was the sense that it was somehow an "antimarket" sentiment to believe shareholders should think far beyond this quarter's results and short-term stock movements, as opposed to pushing for long-term business success.

To fix our ailing market and avoid outright disasters to our economy and the long-term returns in our own portfolios, we need to push for model corporate governance policies. Reasonable CEO compensation policies that are tied to performance, board independence, and shareholder-friendly measures such as majority voting and declassification of boards are all ways to bring checks and balances -- and accountability -- back to our marketplace.

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Check back at Fool.com every Wednesday and Friday for Alyce Lomax's column on environmental, social, and governance issues.

Alyce Lomax does not own shares of any of the companies mentioned. The Motley Fool owns shares of Oracle, Citigroup, and Chesapeake Energy. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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