Letters: The Right Corporate Directors

Archives at the New York Public Library cross-referenced with long-awaited 1940 data provide eye-opening results.

Stuck without a lyric in sight, a songwriter ponders the intricacies of a little bird’s brain.

Fair Game: Board Directors Disappoint

The coming meeting of JPMorgan Chase shareholders, to be held in Tampa, Fla., on May 21, is a case in point. Directors on that board are under fire for not monitoring the bank’s risk management, a failure highlighted by last year’s $6 billion trading loss in the company’s chief investment office. Shareholder advisory firms have recommended voting against some of the directors on the risk policy committee and audit committee, so it will be interesting to see what kind of support those board members receive at the election.

The risk-management fiasco at JPMorgan was an obvious failing, but directors of public companies often let down their outside shareholders in ways that are more subtle, but equally important, say some experts on public company board practices. Directors commonly neglect chief executive succession planning and inadequately analyze company performance as it relates to managers’ pay.

Paul Hodgson, principal at BHJ Partners, a corporate governance consulting firm, said he believed chief executive succession planning was one of the signal tasks of a director and one at which most of them continued to fall short.

“J. C. Penney is the most recent example, but there are countless others,” said Mr. Hodgson, referring to the recent ouster of Ron Johnson, who came to Penney with great fanfare from Apple.

“Hiring an outside C.E.O. costs between three and five times the amount it does to promote an existing manager, so boards are failing in their fiduciary duty and wasting shareholders’ money by not having a properly functioning succession plan in place,” Mr. Hodgson said.

Another board duty that is basic but often badly executed involves how a company’s performance is measured for pay purposes. Mark Van Clieaf, managing director at MVC Associates International, an organization consulting firm, said he believed boards were stuck in a groove that was dangerous for shareholders. The measures most directors use to assess corporate performance, he contends, are too focused on earnings growth and often do not weigh a company’s return on assets, equity or invested capital.

Return on invested capital is a preferred method to measure the creation or destruction of shareholder value, Mr. Van Clieaf said, because it reveals how effective a company is using its money to generate returns. If boards ignore this measure when setting pay, executives could be rewarded even when their companies’ financing costs exceed the returns on their investments. No company can survive in that circumstance for long.

Equally troubling is the board practice of rewarding executives for short-term performance when the risks in their businesses take much longer to play out. The rewards handed over to senior bank executives in the years leading up to the financial crisis, for example, show how unbalanced many companies’ incentive plans are.

Consider the mortgage business. It typically takes as long as five years for problems, like payment defaults, to show up in home loans. Yet most financial companies paid those top executives for performance periods significantly shorter than that.

Back in 2009, responding to the credit debacle, the Financial Stability Board, a group of international regulators and standard setters, published a policy paper recommending principles for sound compensation practices among financial companies. The board said a “substantial portion of variable compensation, such as 40 to 60 percent,” should be deferred over a period of no less than three years. And in 2008, the Institute of International Finance, a global financial industry group, suggested that a sizable portion of executives’ bonuses be deferred over five years.

Both were good ideas, Mr. Van Clieaf said, that have gone largely unheeded. In 2010 he looked at compensation packages at the 18 largest United States banks. “For the 90 named officers of those banks,” he said, “the average performance period was 2.2 years.”

Mr. Van Clieaf has not analyzed these institutions since 2010, but said that other analyses indicated performance periods at most big banks might have stretched to three years, on average. Even that needs to be lengthened, he said.

This short-term orientation on executive pay extends well beyond the financial industry. Last year, Mr. Van Clieaf examined performance periods and metrics among roughly 250 large corporations. He found that less than 4 percent of these companies had both a balance-sheet oriented metric, like return on capital, equity or assets, and a performance period longer than four years.

Another analysis he did, of the 1,500 largest United States companies in 2012, showed that only 18 percent used a balance sheet metric and even fewer — 8 percent — employed performance periods of more than four years.

I ASKED which companies appeared to be taking the right approach. Mr. Van Clieaf pointed to the Eaton Corporation, a maker of engineered products, which bases its incentive pay in part on the cash flow return the company generates on its capital.

Eaton also uses a four-year performance period when setting pay for executives.

Abbott Laboratories, a provider of health care products and services, is another good example, Mr. Van Clieaf said. It uses five-year performance benchmarks and includes return on equity and return on net assets in those calculations.

These companies are in the minority, however. Mr. Van Clieaf blames not only corporate directors but also their advisers and the shareholders who rubber-stamp the misaligned pay practices.

Directors make good money. According to the most recent figures compiled by Equilar, an executive compensation data firm, median pay for outside directors at companies in the Standard & Poor’s 500-stock index was almost $239,000 in 2012. That’s up 11 percent from the median pay awarded in 2010. But that pay comes with a duty: ensuring shareholder interests come first.

“This is a failure to create metrics, performance periods and incentives that are truly strategic for long-term shareholders,” Mr. Van Clieaf said.

“Boards, pay advisers and investors,” he said, “all need a whack on the side of the head.”

Common Sense: Why Bad Directors Aren’t Thrown Out

Imagine having to run on this track record:

¶ After ousting Mark Hurd as chief executive in 2010 amid messy accusations of sexual harassment, the board hired Léo Apotheker to replace him, even though Mr. Apotheker had been fired as chief of the European software giant SAP after just seven rocky months. Most of the board didn’t bother to meet Mr. Apotheker, let alone ask him any probing questions about his tenure at SAP, before rubber-stamping the choice of the board’s four-member search committee.

¶ In 2011, H.P.’s directors unanimously approved the acquisition of the British software maker Autonomy for $11.1 billion, a deal that was considered wildly overpriced even at the time. Less than a year later, H.P. wrote off $8.8 billion of that and claimed it had been defrauded. (Autonomy officials have denied the allegations, which are being investigated by authorities in both the United States and Britain.) Some consider Autonomy to be the worst corporate acquisition in business history. In the 2012 fiscal year, H.P. wrote off a total of $18 billion related to failed acquisitions and other missteps.

¶ With Mr. Apotheker at the helm and the board backing his strategic initiatives, H.P. announced that it was considering abandoning its giant personal computer business, then changed its mind. After Mr. Apotheker had been on the job a disastrous 11 months, the board demanded his resignation, and then paid him more than $13 million in termination benefits.

Shareholders might have forgiven what Fortune magazine called a “tawdry reality show” if the stock had performed well. But from the time Mr. Apotheker was hired in September 2010 until he left in 2011, the stock went from more than $45 a share to a little more than $22. Despite a recent rally, shares are still below $24, even as the Dow Jones and Standard & Poor’s 500-stock indexes are hitting new highs.

“You really couldn’t have a stronger case for removing directors,” Michael Garland, executive director for corporate governance in the New York City comptroller’s office, told me this week. “There’s been a long series of boardroom failures that have harmed the reputation of the company and repeatedly destroyed shareholder value over an extended period of time.”

Yet all 11 H.P. directors were re-elected on March 20.

H.P. is hardly an isolated case. According to Patrick McGurn, special counsel for one of the major shareholder advisory services, Institutional Shareholder Services, shareholder efforts to remove directors in uncontested elections rarely succeed or come close, even in egregious circumstances. Last year, there were elections for 17,081 director nominees at United States corporations, according to the service. Only 61 of those nominees, or 0.36 percent, failed to get majority support. More than 86 percent of directors received 90 percent or more of the votes. Of the 61 directors who failed to get majority approval, only six actually stepped down or were asked to resign. Fifty-one are still in place, as of the most recent proxy filings.

“People are calling them zombie directors,” Mr. McGurn said. But that hasn’t stopped them from serving on boards for what is typically lucrative compensation for relatively little work. (H.P.’s directors received a mix of cash and stock payments ranging from $292,000 to $380,000 in 2012.

While the H.P. board has been largely reconstituted since the Apotheker debacle, all but one (Ralph Whitworth, a well-known value investor who joined in November 2011) approved the disastrous Autonomy deal. Raymond Lane, seen as an ally and supporter, at least initially, of Mr. Apotheker, was named chairman at the same time Mr. Apotheker took the helm. Working closely with Mr. Apotheker, Mr. Lane proposed five new directors. John Hammergren, chief of the McKesson Corporation, has been on the board for eight years, and G. Kennedy Thompson, chief of Wachovia before it was forced into a merger with Wells Fargo during the financial crisis, has been a board member for seven years. Mr. Hammergren was on the search committee that recommended Mr. Apotheker’s appointment.

In its proxy materials, H.P. didn’t address the company’s record under these directors, but nonetheless recommended that shareholders vote for the entire slate, citing the risk of “destabilizing” the company by changing directors in an “abrupt and disorderly manner.” As to Mr. Lane, Mr. Hammergren and Mr. Thompson, it repeatedly cited their “experience” in running global companies, but said nothing about their roles in selecting Mr. Apotheker or other directors, the Autonomy acquisition, other failed strategic initiatives or, indeed, anything at all about their tenures at H.P.

This article has been revised to reflect the following correction:

Correction: March 29, 2013

An earlier version of this article used outdated figures for the board’s compensation in 2012. The directors received a mix of cash and stock payments ranging from $292,000 to $380,000 in 2012, not $290,000 to $355,000, which was the payment range for 2011. The earlier version also misstated the compensation of Mr. Lane, the board chairman, for 2012. He received neither a cash award nor equities in 2012, though he received two large equity awards in 2011.