I once asked the CEO of a large bank whether or not his directors act out of self-interest. His surprisingly candid response was that, yes, every one of his directors acts out of self-interest. A director of a different bank argued in open forum that what the governance field needs are “unconflicted” directors. And a different director of another company (if I tell you the industry you will know the firm, so let’s just say it’s a company) went on to describe over the phone the myriad of conflicts of interest that occur on his board.
Regulators should be concerned with how conflicts of interest and the lack of independence of mind are handled at the board level, where fair dealing and major transactions are approved or recommended to shareholders. Within any organization, conflicts of interest (self vs. the company) should be seen and managed from a reasonable person’s perspective, not from the perceived beneficiary’s point of view. Boards can rationalize their view of whether or not the board or an individual director is operating under a conflict. The standard for the board should be objective, not what the board or an individual director thinks.
There is no reason to believe that directors are immune from acting out of self-interest. The bigger governance question is where is the dividing line between “best interests of the company”—which is an inherently ambiguous concept, and with which directors must comply—and “self-interest”? And how do you know which is which? An example might be moving away from dual class shares or a related party transaction. A personal financial benefit to a director not equally shared by all shareholders should be disqualifying. This dividing line is very important when interests become skewed, especially during a change in control or when responding to a shareholder activist.
When shareholder activism arises, how can a director possibly act without self-interest when her position and professional reputation are at stake?
Is it too much to ask for a director to remain objective when her own financial interests (e.g., future director payments, which can run into the millions) are involved? How can a director remain dispassionate when activist shareholders lay the problems of an underperforming company at the feet of directors? I think the natural response is to fight the activist; otherwise, a board must admit it’s inadequate. Directors understandably are reluctant to go on record saying they act out of self-interest. But we can think of recent examples where interests were skewed and resistance to activism occurred: Yahoo!, Chesapeake Energy, CP Rail and RIM.
There is, however, a mechanism in place to address management’s tendency to act out of self-interest, known as the “golden parachute.” This means that unvested equity can vest immediately if there is a change in ownership and the manager loses his or her job (known as a ‘double trigger,’ the company is taken over and you are dismissed).
The rationale for the parachute is to discourage the management team from resisting the takeover on the grounds of self-interest and instead act in the best interests of the company and its shareholders. Essentially, a manager can “cash out.” This makes far more sense to shareholders, providing of course the parachute is reasonable, as management can move on, save face, and a new management team who can run the company better is put in place. Why are directors different?
The frustration activists have is that board members can’t conceive that their interests and the company’s interests are separate, distinct and often in conflict. One experienced activist and board chair, Henry D. Wolfe, calls addressing self-interest an “ethic of accepting personal responsibility.” Wolfe was asked what the proper reaction of the CP board of directors should be to Pershing Square, a shareholder activist. The immediate answer was, “The CP board’s first response to the case that Pershing Square has made should be to take a hard look in the mirror.”
Wolfe went on to explain, “This was not intended to be flippant but a serious response made in a simplistic fashion. The intended point was that the members of the board should have the character to be willing, in the face of such overwhelming analysis, to accept personal responsibility for the shortfalls in CP’s performance. This is not a suggestion that they should resign in mass but that they should be willing to take a hard look at reality rather than entrench behind new promises to shareholders after years of repeated and announced performance improvement initiatives that have not borne fruit.”
Maybe Wolfe is expecting too much from boards. Maybe it is unrealistic to expect directors to “do the right thing” when their personal and financial interests are involved. If I am right, there may be merit to directors having their version of a “golden parachute.” Perhaps a “platinum parachute.” Shareholders should like this idea, for the above reasons.