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Directors & Boards
Robert H. Rock
Publisher
James Kristie
Editor
Lisa
Cody
Chief Financial Officer
David Shaw
Publishing Director
Scott Chase
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The Directors & Boards e-Briefing is produced by GRID Media LLC.
From Jim Kristie | Article of the
Month | Columnist
Reader Profile |
Research | News |
A Time of
Pushback ... and Pushing Ahead
SOX has been all about a board’s custodial
and fiduciary roles. The action now needs to shift decisively to the
board’s role in strategy.
Welcome to the year of Sarbanes-Oxley pushback.
Perhaps pushback is too strong a word. After all, SOX is the law of the
land and unlikely to be reversed. But what seems to be kicking in is
the recognition that SOX mania in the boardroom has 1) stressed the
governance system in a threatening way, and 2) that it’s time to
redirect the directors to be advisers and strategists, not bean
counters and legal eagles.
The “Dump Donaldson” drumbeat, heard loudly last month, is one
pushback. Other pushback rumblings (“Sarbanes-Oxley has gone too far”)
were heard in several venues as the year drew to a close -- from the
formal setting of a high-level governance conference put on in December
by the New York Society of Security Analysts to informal holiday
gatherings attended by habitues of Wall Street and company boardrooms.
More evidence of pushback is reflected in the thoughtful set of
observations, “Call Me a SOX Skeptic,” presented below from Murray
Weidenbaum, no stranger to the halls of government or the inside of a
boardroom.
These aren’t unprincipled rebels doing the pushback. They are
individuals who recognize, implicitly or explicitly, the danger of
misusing the asset that a board of directors is. Here at Directors & Boards we have
pounded the table for more than two decades that the board has a vital
role to play in strategy development. As the late governance guru
Thomas Horton wrote in our pages 20 years ago, in advocating that a
board establish a strategic planning committee as a standing board
committee, “The board is too valuable a resource to be used only for
its custodial and fiduciary purposes.”
The SOX action has been in the custodial and fiduciary areas. The
action now needs to shift decisively to the strategy area. In a way,
the spurt in M&A activity as the year drew to a close is a pushback
on SOX. It shows that boards are stepping up to strategic risk again,
which is a good thing.
Let’s monitor how the pushback continues to play out. Feel welcome to e-mail me with any
pushback observations that you may have.
Jim
Kristie is the editor and
associate publisher of Directors & Boards.
*****
Directors & Boards is
pleased to sponsor The Wall Street Transcript's Executive Compensation
Analysis Conference, January 11-12, 2005 at the Harvard Club in New
York City. Call
Naomi Barazini at 212-952-7454.
Call Me a SOX SkepticWhen it comes to regulating corporate governance, the ‘magic of the marketplace’ will work just fine, thank you.
By Murray Weidenbaum
We are in the midst of an unusually rapid expansion of federal
involvement in corporate governance. As a long-term corporate director,
I feel impelled to report a personal attitude that departs considerably
from the views that we economists hold on the subject of regulation.
Just for the record, I have devoted a substantial portion of my
academic research to evaluating the impacts of regulation on American
business, especially manufacturing. Early on, I advocated the
introduction of benefit/cost analysis to screen proposed regulations.
This approach enables the analyst to take an ostensibly neutral
position, giving equal weight to the benefits and the costs. I did
learn that, if you are in the middle of the road, you will be hit by
traffic going in both directions.
As a board member, however, I instinctively view regulatory
requirements in a negative light -- as an annoying and unhelpful
intrusion. Having led the ouster of the CEOs of two large companies, I
may have a different view of the boardroom than others. Surely, there
are serious matters that directors face in dealing with the chairman
and the management -- especially when the two roles are combined. My
point is that I do not find government officials helpful in that
process.
Surely, if the requirements imposed by Sarbanes-Oxley (SOX) result in
substantially greater confidence in the financial reporting of American
business, the results may well justify the added costs being imposed. I
remain a skeptic, however, because I believe that the Enron experience
had a greater -- and more positive -- impact. Indeed, Enron continues
to be a presence in many boardrooms today. No director wants to suffer
the fate of the Enron directors who were tossed off other boards just
because they wore the Enron badge of shame.
[Read
the
Full Article]
Stranger Than Fiction
Governance doings that
approach the fantastical.
In junior high school English class, we were at one point required to write about “an unforgettable character.”
Creating a fictional character, I figured, would be way too hard (and way too much work). Why not just write about an actual kid from the neighborhood? So I wrote and submitted a composition that recounted three or four bizarre incidents involving this kid. I had witnessed them all. Everything I described in the paper was true.
When it was graded and returned, I saw that the teacher, Mr. Silver, had written this comment on the last page: “Somehow your character doesn’t quite jell.”
What was he getting at? I wasn’t entirely sure. I asked my mother, a former high school English teacher. “He doesn’t believe your character.”
“But he’s a real person,” I protested. “Every story happened exactly as described. He’s an ‘unforgettable character’ because his actual behavior is so screwy.”
Now that the year 2004 is history, it is instructive to examine recent governance events through the lens of Mr. Silver’s critical approach to creative writing assignments. Let us assume that those events have been transformed into movie treatments and pitched to a middle-level movie exec for possible production.
1. Disney
Thumbnail sketch of the Disney melodrama:
(a) The CEO-character brings in as his No. 2 a hugely successful, immensely powerful Hollywood personage who proceeds, within short order and notwithstanding his prior success, to demonstrate utter incompetence.
[Read the Full Article]
Chairman and Co-Founder
The Blackstone Group
Editor's note: Each month, we ask a
Directors & Boards
reader to comment on critical issues facing
directors today. If you'd like to participate in this section in
the future, please email Scott
Chase.
What do you believe that Boards of Directors should be most concerned about?
I guess I worry that some combination of continuing corporate scandals and legislative hyper-activism might lead to some misdirected legislative “solutions” to executive compensation.
History teaches us the sad fact that Congressional action, particularly in the area of executive compensation, often has serious unintended negative (and sometimes ironic) consequences and rigidities. We observed these negative consequences when Congress placed a cap of $1 million on cash compensation deductibility, inadvertently setting off an explosion in awards of fixed-priced stock options and rapidly inflating senior compensation in the process. This kind of unfortunate Congressional involvement is the political equivalent of what the medical profession calls the iatrogenic effect, a side effect or disease caused by the “iatro,” the doctor.
Why do you focus on executive compensation?
Because I continue to feel that this is the elephant in the boudoir that we all want to pretend is not there and hope no one else points it out.
When our Conference Board Commission on Public Trust and Private Enterprise, co-chaired by John Snow and me, started our work in this area, I assumed that the widely reported, generic increases in executive compensation would present the major problem to the public. All of us on the Commission had read the BusinessWeek report showing that, over a 10-year period, compensation had risen about 9½ times faster for CEOs than for rank-and-file employees. We also knew that BusinessWeek had reported that in 1980 CEO compensation was 42 times that of the average workers, whereas in recent times it was roughly 500 times that average—far higher than in Japan and Europe.
[Read the Full Article]
Directors & Officers Insurance Premiums
Decline for First Time since 1999
Tillinghast's Directors & Officers (D&O) liability insurance premium index dropped 10% from 2003 to 2004, the first decline since 1999, according to the 2004 Directors & Officers Liability Survey, done by the Tillinghast business of Towers Perrin. However, claim susceptibility, frequency and severity are still soaring.
Tillinghast's survey, which included 2,455 participants, is the 27th in a series of studies on D&O liability claims and insurance purchasing patterns and the most in-depth study of its type.
According to this year's survey, much of the current softening in the D&O market is not due to a reduction in claim activity, but rather can be attributed to the entrance of new capacity. Competition is particularly fierce in excess layers for large public companies, where rates are dropping 10% to 15%.
Despite the softening market, some pockets of hard market conditions remain, particularly in banking, health services, and real estate and construction. Looking at the historical data, it appears that 2003 was a turning point in the market; however, Tillinghast cautions not to expect the trend to continue.
"This soft market for D&O insurance will be shorter and less pronounced due to lower investment returns than in the 1980s when cash flow underwriting was prevalent," said Jim Swanke, Managing Principal for the Strategic Risk Financing Practice. "Carriers will likely need to begin increasing rates in the short to medium term in order to maintain their return on equity."
Capacity increased 11% to $1.5 billion in full limits from 2003, and a record number (99%) of U.S. participants reported having D&O insurance. Fewer respondents cited "cost" as the main reason for going without coverage (44% of participants in 2002 versus 26% in 2004).
"The survey tells us that coverage is being offered broadly in the market, with decreased premiums, increased limits and enhancements, and fewer exclusions," said consultant Elissa Sirovatka, who leads Tillinghast's D&O Liability Survey program. "What's disturbing is that this is occurring at the same time frequency and settlement costs are still rising."
Among repeat participants*, claim frequency increased 11% from 2003 to 2004 and claim susceptibility increased 6%. Average severity for repeat participants increased in three out of five claim classes, including employees/unions/physicians, competitors/suppliers/contractors, and shareholders/investors.
"The continued increase in the average cost to settle D&O claims combined with the significant number of open megaclaims makes a tough case for a sustained soft market. The claim conditions we're seeing justify premium increases rather than decreases," said Sirovatka.
Top sources of allegations from shareholder claimants (general breach of fiduciary duty, inadequate/inaccurate disclosure, including financial reporting and stock or other public offering) and employee claimants (discrimination and wrongful employee dismissal or termination) were the same for 2003 and 2004.
Surprisingly, though, allegations citing accounting fraud also remained the same at 2%. More than half (56%) of claims against 2004 participants are still open, which is up from 37% in last year's survey. "The increase in open claims along with the increasing settlement costs will make it difficult for insurers to get a handle on their reserves for D&O liabilities," said Sirovatka. "Couple this with premature pricing declines and a softening market, and insurers could be heading toward a D&O reserve shortfall if we don't start to see more disciplined underwriting and adequate pricing."
Other highlights of the survey include:
-- Some Pockets Still Resist Softening - Premium increases were reported on average for business classes such as banking, durable goods, health services, and real estate and construction, as well as those in respondent size categories of $10 million to $50 million and $5 billion to $10 billion. Increases were far more common for Canadian participants, where 90% of respondents reported premium increases over the past five quarters.
-- Coverage Broadens For Most - The number of U.S. participants reporting increases in deductibles/retentions in this year's survey (28%) is down drastically from last year (44%). Following this trend, 13% of participants reported increased coverage enhancements (the highest level since 2001) and 10% reported a decrease in exclusions (the highest level since 1999). Average policy limits increased for most asset classes from 2003 to 2004, except for companies in asset classes $400 million to $1 billion and $1 billion to $2 billion, which saw 8% and 13% decreases, respectively.
Looking Ahead
Tillinghast doesn't expect the current soft market for D&O liability insurance to last through 2005 and predicts a return to a hard D&O market by 2006. Tillinghast also anticipates continued upward pressure on frequency and severity of loss.
"The market peaked in 2003, and we feel that this decline in rates was far too premature in terms of premium adequacy," said Sirovatka. "We expect to see a leveling of capacity moving forward, continued pockets of rate increases and a smaller magnitude of rate decreases as the market digests this 'too much, too soon' softening."
Reinsurance Implications Experts in the Reinsurance business of Towers Perrin say that reinsurers will be paying close attention to the D&O marketplace in 2005. "We expect that in 2005, in an effort to limit their loss from any one occurrence, reinsurers will be more cautious in supporting multiple carriers' D&O programs, which could aggregate loss to the reinsurers as a result of a single large loss scenario such as Enron," said Michael Hollenbach, Professional Liability Practice Leader.
"Furthermore, the effect of Sarbanes-Oxley is yet to be determined; we're waiting to see whether the increased duties imposed on management will drive additional claims." Roland Stollsteimer, Senior Vice President, concurred that 2005 renewals will be a critical test for the D&O market; however, he is cautiously optimistic about some sectors of the business. "Competition and capacity among primary D&O insurers have aggressively gravitated toward the private company and nonprofit sectors."
Participant Profile
The 2,455 companies surveyed included 2,409 from the U.S. and 46 from Canada, in 15 business classes across all major industry groups. In the U.S., participants in technology, biotechnology and pharmaceuticals, and governmental and other nonprofit classes represented 65% of respondents. The distribution of participants by assets and revenues has shifted to a greater percentage of small companies than in our 2003 survey. In particular, 52% of 2004 participants reported assets less than $10 million, compared to 35% of 2003 participants. Overall, 30% of the U.S. participants are publicly held organizations, 52% are privately held and 18% are nonprofit.
*Repeat Participants - This year, we introduced a new section to our survey. This section on repeat participants, of which there were 1,347, looks at the results of our survey for organizations that responded to both our 2003 and 2004 surveys. We added this section to look at trends in claims from 2003 to 2004 for a consistent group of participants.
The 2004 Directors & Officers Liability Survey is available on a prepaid basis for $700. Tillinghast also offers a companion report service, which enables risk managers and other D&O professionals to efficiently and cost-effectively compare an organization's D&O program with information compiled from its peers with similar exposure characteristics.
Both can be ordered by contacting Mary Maze at (312) 609-9347 or via e-mail at mary.maze@towersperrin.com.
January
11-12, 2005
The Wall Street Transcript's Executive Compensation Analysis
Conference: Designing & Implementing a Rebalanced Executive Pay
Package will be held at the Harvard Club in New York City. Register by
December 17 and save $350 when you mention Directors & Boards!
Contact Naomi Barazini at
February
2, 2005
The Practicing Law Institute will conduct "Corporate Governance 2005:
Dealing with the Governance and Disclosure Challenges Ahead." The event
will be held in New York. It will include sessions on Emerging Best
Practices in Corporate Governance, Lawyer Ethics, Executive
Compensation, and Annual Report Disclosure. For more information, call
1-800-260-4PLI, or visit
March
1-3, 2005
Harvard Business School Executive Education conducts its Compensation
Committees: Preparing for the Challenges Ahead program. For more
information, visit
March
16-18, 2005
The Directors' Education Institute at Duke University is an intensive
two-day program developed by the Duke Global Capital Markets Center
with the support of the New York Stock Exchange. With participation
from leading executives, corporate directors, policymakers, and experts
from the legal and financial services industries, along with academic
authorities from the Fuqua School of Business and Duke Law School, the
program will teach participants how to develop a framework for making
informed board decisions and exercising sound business judgment. For
additional information, visit
The Association of Governing Boards of Colleges and Universities (AGB) will present its National Conference on Trusteeship. Sessions include "Managing Health Care Costs," "Creating a Reform Agenda for Public Trusteeship," and "Sarbanes-Oxley: How Does It Really Affect Higher Education." To register, call 1-800-356-6317 or visit the AGB Web site at http://www.agb.org.
April 26-29, 2005
The J.L. Kellogg School of Management at Northwestern University will host a conference on "Corporate Governance: Effectiveness and Accountability in the Boardroom," designed to "energize" a director's thinking and "empower you with new tools, concepts and strategies to meet the new challenges of your critical governance role." Visit http://www.kellogg.northwestern.edu/execed or call 1-847-467-7000 for registration information.
Directors
Guide: Corporate Aviation
D&O
Forecast
Harvard Alumni Achievement
Directors & Boards author Barbara Franklin was one of five recipients of the Alumni Achievement Award conferred by the Harvard Business School, the school's highest honor. Her citation notes: "As U.S. Secretary of Commerce in 1992, Barbara Franklin reestablished ministerial trade contacts between the United States and China after they had been suspended for several years. One of the first women graduates of HBS, Franklin is used to breaking down barriers. She has worked with five Presidents of the United States, founded an international trade consulting and investment firm, and earned kudos as a corporate governance expert." Her most recent appearance in Directors & Boards was as a "Reader Profile" subject in the July e-Briefing.
So. Cal Leader of the Year
Directors & Boards author Peter Mullin, founder and chairman of Mullin Consulting Inc., was presented with the Southern California Leader of the Year Award in December 2004. He was honored for his four decades of service to Los Angeles business and civic organizations. His most recent article for Directors & Boards was "The Traps in Designing Benefit Packages" in the Second Quarter 2004 edition.
Miller Outstanding Achievement Award
Jay Alix, chairman & CEO of AlixPartners LLC, the turnaround, performance improvement, and financial advisory firm, as well as chairman and CEO of Questor Management Co., a turnaround buyout fund focused on investing in underperforming and distressed companies, received the Harvey R. Miller Outstanding Achievement Award for Service to the Restructuring Industry at the Distressed Investing Conference in New York. AlixPartners has been the source of several important crisis management advisories for Directors & Boards, including "When It's Time to Say, 'Stop This Bus!'" in the Fourth Quarter 2004 edition.
Cadmus Matters
Cadmus Communications Corp., printer for Directors & Boards, has been selected for the EContent 100 List of "Companies that Matter Most in the Digital Content Industry." Cadmus is a leading provider of content processing and delivery solutions for scholarly and professional publishers.
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Directors & Boards e-Briefing is a monthly service of Directors & Boards. All contents copyright 2005, MLR Holdings LLC.