Kay Review interim report pushes against short-term pressures

How do we wean companies and markets off the notion of short-term performance to focus on the long-term needs of the economy and society? Is a tough question, especially when experience shows that the lack of discipline from deliverables can lead to lazy management. After all, the long term is, by definition, the sum of successive short terms. The UK government is having a go at it, in a long, three-stage process of consultations and reports, the second of which has now been published. The iconoclast and economist John Kay is fronting the process, a person with a subtle mind for complexity who is nonetheless an advocate of order. "The proposals for reform we have received bear on many different areas of policy – such as the governance of companies, the ways in which economic activities are measured, the functioning of markets and the structure of the savings market," Kay writes in the introduction.

The report has at its centre the theme of ownership, a difficult concept in equity markets, and particularly one with the complexity that has developed in mature ones like the UK. "There are at least three relevant aspects of ownership," the interim report states: "Who makes the decision to buy or sell a particular holding? Who decides how the voting rights attached to the shares should be exercised? Who enjoys the economic interest in the shares?" They may not be the same, which is what makes this review difficult. Rather than detailing recommendations, it summarises concerns, among them:

• Companies and boards: The report states, for example, "the concept of stewardship implied a group of people committed to the long term success of the company, rather than a rotating panel of temporary appointees. Perhaps there is no set of rules that can define the composition of an effective board."
• Measurement and reporting: On accounts and accounting standards: "They must present a true and fair view of the affairs of the company and also contain information about the past, present and future. Not only will elements always be volatile, but subjectivity is also inevitable. It is not realistic to imagine that any prescribed body of quantitative data can fully meet all these purposes."
• Market practice: The large number of large foreign companies listed in the UK attracted a lot of comment. The review notes that the undue weighting these have in investment portfolio is often a choice the funds themselves have adopted. Could they not change their own rules?
• Asset managers: Kay likes the distinction drawn by the Investment Management Association between "investors" and "traders", calling it "helpful and important. It is investors who directly serve the purposes of equity markets in improving the performance of companies and generating returns to beneficiaries, and it is investors who obtain the information which is needed if share prices are to reflect the fundamental value of companies."
• Intermediaries: "There are many intermediaries, and many levels of intermediation," the interim review states. The unstated implication is that there are too many. "Does the interposition of many intermediaries, with business objectives which are not necessarily aligned with the interests of companies and beneficiaries, conflict with the underling objectives of promoting these interests?"

The review involves as well a further consultation, with responses due by April 27. The final report is expected to be published in July, and is likely to involve recommendations on matters like taxation that lie outside the brief of the Department of Business.

Source document: The interim report of the "Kay review of UK equity markets and long-term decision making" will be followed by a further consultation with final recommendations due in July.

Italy details enforcement of gender balance for boards

The Italian securities regulator Consob is modifying its procedures for monitoring board composition in light of the enactment of gender balance for listed companies. Some women may wonder how successful the exercise will be when the enforcers themselves use the shorthand "quota rosa" or "pink quota" to describe the provision. Still, it promises that sanctions will be applied: "If the composition of the board resulting from the election does not comply with the division criterion, Consob will warn the company to comply with the legislative provisions within the maximum term of four months. In the event of non-compliance, Consob will impose a fine and set a new term of three months within which the company will be obliged to adjust the composition of its boards."

Source document: The Consob newsletter, in English, has gender quotas as the second item.

Code of conduct for UK private equity firms gains adherence

UK private equity firms have begun to embrace the voluntary guidelines promulgated just before the financial crisis pushed then out of the headlines as the bad boys of the financial world. The negative press they had received was probably misinformed, but it led to a move that was probably a good thing: disclosure of the working practices of private equity firms and greater reporting about the companies in which they invest. The findings of the fourth annual review by the Walker Guidelines Monitoring Group identified a higher level of overall compliance than in previous years. "These results are particularly encouraging as the Group has continued to raise the required standard of overall disclosure," it said. Nonetheless, the quality of disclosure varied significantly. The portfolio companies who tested the best report at a level equivalent to, or in advance of, FTSE 350 companies, it concluded.

Source document: The GMG monitoring report is a 36-page pdf file.

What's a CEO worth?

The pay of top executives is hot topic. Are they coddled and overpaid, or do they just get the market rate? How imperfect is the market in which they compete for the top jobs? Perhaps the biggest question of all is how much to they deserve the pay they get? This last question is often answered with appeals to value creation, in particular the rise in the share price under the CEOs tenure. That's a difficult question to answer, but one that nonetheless gets asked in a new instalment of the "Closer Look" series of guides to corporate governance published by the Stanford University Graduate School of Business.

Among the questions it tries to answer are: How much value creation should be attributable to the efforts of the CEO? What percentage of this value should be fairly offered as compensation? Can the board actually perform this calculation? If not, how does it make rational decisions about pay levels?

Source document: The think piece "What is CEO Talent Worth?," by David Larcker and Brian Tayan, is an eight-page pdf.

Which parachute is the most golden?

The "walk-away" package is an increasingly expectation among corporate executives in the US at least. It isn't the gold parachute of old, structures put in place to give a CEO protection in case he was ousted in a hostile takeover bid. Nor is it the payment for failure, a way to pushing the executive less reluctantly out the door, with a payment for silence. The walk-away is something different. It sudden grew in prominence after Jack Welch retired from General Electric and subsequent his divorce settlement forced into public view his perquisites valued at $2.5 million a year. According to a report by the proxy researchers at GMI, since then, multi-million dollar severance and other separation packages have become so commonplace that we scarcely notice them. Recent HP parted company with CEO Leo Apotheker and with $12 million, with hardly a mention. Companies now accelerate equity awards along with substantial pensions and other deferred compensation all but guarantee significant payouts at many of the largest US corporations. GMI has published a report going back to 2000 to examine the largest golden parachutes and other termination packages of the past decade, many of which have never been quantified before. Here are some of the highlights:

• The top 21: Some 21 CEOs received walk-away packages in excess of $100 million since 2000.
• The top awards: Walk-away packages include actual and potential stock option profits, full-value stock awards, continuing salary and bonus payments, health care benefit and continuing perks, additional pension benefit.

Among the cases involved, the tenure of the CEOs ranged from nine months for Viacom's Thomas Freston to 29 years for North Fork Bank's John Kanas, with both extremes raising questions about what justified the additional payments. Perhaps most surprising were the cases of three CEOs who received payouts without ever leaving.

Source document: The GMI report is a 10-page pdf file.

EU rethinks its role in scope of corporate activities

The European Union has a long and ambiguous role in shaping the nature of corporate activities. Member states like to keep control over what is and is not a company, that is, over who is and is not entitled operate as one under their individual laws. A European Company statute came into being some time ago, allowing a company to register in a way that allowed it to operate as one entity without registering subsidiaries, but its scope has been limited. Now the European Commission wants to take another look at the whole area of European involvement, and it's asking a series of questions:

• Objectives and scope: What should be the main objectives of European company law? Are the current rules fit for today's challenges? In which areas is there need for further evolution? What relationship between company law and corporate governance?
• Codification : Should the existing company law Directives be merged in a single instrument in order to make the regulatory framework more accessible and user-friendly?
• Future legal forms: What are the advantages and shortcomings of European company forms? Do existing company forms need to be reviewed? Should alternative instruments be explored?
• Cross-border mobility: What can be done to facilitate the cross-border transfer of a company's seat? What if a company splits into different entities cross border? Should the rules on cross border mergers be reviewed?
• Groups: For a set of companies under a single management or source of control, is there need for EU policy action in this field?
• Capital: Should the existing minimum legal capital requirements and rules on capital maintenance be modified and updated?

These are pretty sweeping questions and ones where member states will probably have quite a bit to say about how much Brussels gets involved. But with the eurozone crisis leading to constraints on the sovereignty of governments in much of fiscal and economic life, this type of inquiry might well seem a natural extension, particularly if it seems to be eliminating roadblocks to economic growth. The consultation closed on May 14.

Source document: The consultation website has further details of the questions.

A 'biased' guide to behavioural ethics

The problem with ethics is that everybody wants to tell you what to do. That's what scholars like to call the "normative" approach, and it lies at the heart of most of the discussion about ethics in business: what's the right thing to do, and what's the wrong thing. There is another approach, one the sounds more like social science and less like theology, however, and it's deeply unsatisfying to those who long for, or search for, the right answer. Behavioural ethics, like behavioural finance or governance, seeks to examine what people do, rather than what they (or, indeed, others) say they should do. According to two scholars from Harvard Business School, this descriptive approach still teaches lessons, just not of the top-down sort. The names Enron and Madoff have resonance even without a rule by which to judge them.

"As business school professors, we are disappointed with what academics have offered to date in response to these increasingly frequent demands," they write. "More importantly, we believe that there are limitations to the strategies used in our efforts as academics to respond, and believe that there are more effective ways that can help reduce ethical failures in both business and society more broadly in the future." So how, then?

The pair set off to recounts their self-confessed "biased" view of the history of business ethics and the attempts by professional schools to address it in teaching and research. Behavioural ethics "sees an opportunity in helping students and professionals better understand their own behavior in the ethics domain, and compare it to how they would ideally like to behave". Reflecting on the experience is itself the moral education.

Source document: The working paper "Behavioral Ethics: Toward a Deeper Understanding of Moral Judgment and Dishonesty," by Max Bazerman and Francesca Gino of Harvard, is a 43-page pdf file.