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Many investors have become accustomed to -- and even desensitized to -- a common practice in American corporate boardrooms: chief executive officers who serve double duty as chairman of the board of directors. The ability to don two hats may sound "efficient," but don't be fooled. This tricky policy not only impedes board independence, but it could also add up to millions more in costs to shareholders and less robust long-term returns.

Double jeopardy
GMI Ratings, which provides global corporate governance and environmental, social, and governance, or ESG, research, recently released a report exposing sobering data about companies where CEOs reign supreme over their boards of directors.

GMI's research examined 180 companies with market caps of $20 billion or more. As it turned out, the data showed that when a CEO also held the chairman title, that individual was paid far more than chief executives who didn't also serve as chairman. In fact, executives holding the joint roles were paid more than the combined expense of having both a CEO and a separate chairman.

Median CEO pay at companies with a joint CEO/chairman was a bit more than $16 million. The median pay for CEOs who did not also hold the chairman title was considerably less: $9.8 million in total compensation.

GMI also found more ESG risk at companies where the titles were combined. The research firm awards (or rebukes) companies with ESG ratings of A through F. In fact, 31.74% of companies with the joint role had been given an "F" grade, as compared with just 15.87% of the companies that had separated the roles.

Some examples of major companies with CEO/chairmen and failing grades from GMI Ratings included Goldman Sachs (NYSE: GS  ) , News Corp. (NYSE: NWS  ) , Wells Fargo (NYSE: WFC  ) , and Coca-Cola (NYSE: KO  ) .

GMI's ESG ratings reflect heightened risks on many levels, including the serious risk of aggressive accounting.

In addition, GMI took a look at shareholder returns over different timeframes and exposed some fascinating data. In the short term, it appeared that companies with a combined CEO/chairman role fared better; the median one-year performance of companies with combined roles was 11.7%, versus just 2.3% for counterparts that had separated the roles.

However, the perspective changes greatly over a timeframe that's better aligned with true long-term value. The median return over a five-year period for companies with combined roles was 31%. Companies that had separated the roles pulled ahead significantly over five years, with median performance of 40%.

It's good to be the king (if you're the king)
Even without the financial component showing that these individuals are more costly, the conflict of interest inherent in this practice was a pretty logical takeaway to begin with. Boards of directors are charged with protecting shareholder interests, but a CEO who also heads up the board isn't likely to be unbiased. In fact, it's a situation that's easily closer to a dictatorship.

Common sense tells us that a board of directors is more likely to push back against shoddy management practices if the chairman is independent of the company in question.

The sites of some of the worst corporate scandals happened to have CEOs who also presided as chairmen of their boards of directors, giving these already powerful individuals far too much authority. Think Enron, Tyco, and WorldCom. Is it an accident?

Meanwhile, this topic underlines why shareholders have been pushing back hard given Chesapeake Energy's (NYSE: CHK  ) years of shareholder-unfriendly behavior and increasing numbers of scandals involving CEO Aubrey McClendon. McClendon was recently stripped of the dual role of chairman of that company, but the move's coming late, given years of serious corporate-governance problems at Chesapeake.

Sleight of hand: tricks that make shareholder value disappear
Too many shoddy corporate-governance practices have been passed off as "business as usual" as investors assumed their interests were being served. This has especially been problematic as investors fell prey to the pitfall of relying too much on short-term metrics like this quarter's earnings or today's stock price.

Pro-management corporate interests have scoffed at concerns about such practices that always ensured that managers benefited above all else, including sound business practices and growth, not to mention investors' own long-term interests. All that scoffing has been a classic case of misdirection.

Keep an eye on this tricky policy, and vote for separating the chairman and CEO roles in your annual proxy statements. Checks and balances build the strongest companies, and it's a rare leader who can justly juggle the responsibility of heading up a corporation and the board. For the most part, this policy promises a loss of shareholder value over the long haul.

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

Alyce Lomax owns no shares of any of the companies mentioned. The Motley Fool owns shares of Coca-Cola, Wells Fargo, and Chesapeake Energy, as well as having created a covered strangle position in Wells Fargo. Motley Fool newsletter services have recommended buying shares of Goldman Sachs, Wells Fargo, Chesapeake Energy, and Coca-Cola. We Fools don't 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. The Motley Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 04, 2012, at 9:09 PM, iswhatitis wrote:

    Have you guys beat this mule enough yet?

    You know no more then any other. Buy your own mule and beat it.

  • Report this Comment On July 05, 2012, at 1:42 AM, strelna wrote:

    I think this piece is broadly right but it must not be forgotten that a board is a committee. As such, it can be a drag on an exceptionally talented CEO wishing (rightly) to make bold forward moves. A really good chairman of great experience will immediately recognize this (with delight) and allow latitude. A nervous and un-entrepreneurial chairman, one perhaps who would really be happier in the state sector, can adversely influence the board into caution.

    I think the answer is to watch an adventurous CEO very closely to ensure he has shareholders' long-term interests at heart. The board must do their duty in the absence of a company chairman ands shareholders should enquire of the board if they do not.

    It is true that, humans being what they are (gullible), CEO charisma can make this difficult. A focus on what is happening using only the figures helps.

  • Report this Comment On July 05, 2012, at 1:33 PM, TMFDarwood11 wrote:

    Good article.

    I generally agree that wearing too hats as CEO/Chairman is all to often to the detriment of the shareholders.

    However, there are exceptions. I've held both hats for the better part of 20 years. As the CEO/Chairman I took in on the chin for the team and there were a few years my administrative assistant made more than I did. However, I never considered that to be a problem. I had stock in the company and my goal was to maximize shareholder value over the long term, which was to my benefit.

    As readers at the MF are aware, I'm also an advocate of "clawback" provisions. Many CEOs hand pick their successor. In so doing they are determining critical aspects of the future of the company. For those CEOs who take a "hands off" approach to this, I say they too are significantly involved. In other words, making a few quarters is useless to "buy and hold" investors. I think prudent stewardship should be rewarded and the opposite should be punished. If one doesn't like it, they can get a job in the stock room and play it safe.

  • Report this Comment On July 05, 2012, at 4:32 PM, TMFLomax wrote:

    Darwood11, thank you for your comment. We need more corporate leaders to handle themselves as you've described, focusing on the long term and having the willingness to make some sacrifices for the team. Awesome.

    Unfortunately, I think the conflict of interest in the shared CEO/chairman quandary is too much for many individuals. I do believe some rare leaders can handle the shared roles gracefully and with humility enough to make it work, but unfortunately, too many do not.

    Thanks for sharing the thoughts, everyone.



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