This event sparked the wave of protests across the Arab world which has come to be known as the “Arab Spring”. While injustice is the driving force behind this movement, the ability to communicate, attain information, coordinate protests, and document atrocities for the world to see in real time, has been forever changed by the introduction of technology, particularly mobile phones and social media; without the iPhone (AAPL) or Facebook, there’s a chance the movement would have stalled long ago.
While technology has brought accountability to the forefront in emerging/developing markets, it has slowly begun to creep into the developed world, albeit in a slightly different fashion. Investors have been early witnesses to this transformation, in a long trend that will hopefully accelerate as a result of an informed and actionable population (in the form of shareholders); I believe that we are in the early days of a shift towards accountability and stronger corporate governance.
Aubrey McClendon, the CEO of Chesapeake Energy (CHK), came into the light this past week for a controversial “founder well participation program”, which has been in place at Chesapeake since 1993; the program, which allowed Mr. McClendon to take a small stake (2.5%) in the wells that the company drills, will be ended before its scheduled expiration in 2015, largely due to unwanted media focus around the questionable deal structure and related loans. Yet even with that saga drawing to a close, you rarely find just one cockroach in the kitchen: it has now emerged that a director responsible for setting Mr. McClendon’s compensation in the late 1990’s was simultaneously the provider of a personal loan to the CEO, a blatant conflict of interest.
Two weeks ago, shareholders voted down Citigroup (C) CEO Vikram Pandit’s $15 million pay package, with 55% of the company’s owners saying that the compensation was excessive or unjustified; this is the first time that a financial giant has been told “no” since Dodd-Frank required public companies to include “say on pay” votes for shareholders. While the vote isn’t binding, it’s interesting to hear the words of renowned banking analyst Mike Mayo Mike of Credit Agricole Securities: “This is a milestone for corporate America. When shareholders speak up about issues on which they’ve been complacent, it’s definitely a wake-up call.” (On a side note, investor’s should read Mr. Mayo’s book discussing his years as a banking analyst, entitled “Exile on Wall Street” - it’s an interesting look at an often opaque part of the investment world).
In my view, these two isolated incidents represent the early days of what will slowly but surely signal the continued transition to stronger corporate governance on a global scale. In the case of Mr. McClendon, the ability to hide behind footnotes in financial statements has been uprooted by a potent combination of fact-checkers (such as Footnoted, a service from Morningstar (MORN)) and the unrestricted dissemination of information. In 2009, for example, Footnoted found in CHK’s proxy that the company had spent $12.1 million buying antique maps from Mr. McClendon, a questionable purchase to say the least (it won the company’s “Worst Footnote” prize for 2009). Two years later, after bad press and shareholder lawsuits, the company caved and announced that Mr. McClendon would pay back the $12.1 million purchase price, plus 2.3% interest.
In Mr. Pandit’s case, we are seeing a transition away from “rubber stamp” annual meetings and towards a system where accountability is mandatory. Most annual meetings are now available over the internet as either audio or as a webcast, with protesters showing up in force to give managers a piece of their mind; while some may write this off as a sideshow of sorts, and inconsequential in the grand scheme of corporate decision making, I think that management recognizes that these groups can (in some cases) materially affect their business interests, and would be best served to remain cognizant of their concerns.
To be clear, I think this process will take time. Importantly, the most critical aspects of the agent-principal problem have been glossed over, and will need to be reexamined before real change can take place; until the board of directors becomes an accountable balancing force to the executive team (having a CEO hold the position as chairman guarantees this WON’T happen), and the managers are actually held accountable for their actions (as Warren Buffett (BRK.B) says, we need to change the incentives ("it's nice to have carrots but you need sticks") - any bank that had to go to the government for help should result in the CEO and his wife forfeiting their entire net worth), the wheels will keep spinning without gaining much traction.
However, despite the hurdles that lie ahead, I can honestly say that I’m more optimistic on this front then I’ve been in a while. David Poppe, money manager at the well known Sequoia Fund, posted his annual letter to investors last Thursday, and has reignited a discussion that must remain at the forefront among investors: who is on the board as my representative as the business owner, and are they the best person for the job?
We must ask these questions; more importantly, we need to be given real answers.
As shareholders, we must remain cognizant of the proposals at hand, and vote accordingly; with unlimited access to corporate filings and channels of communication, we must stay in touch with our fellow investors and work to collectively drive corporate initiatives that enrich the owners of the business, not just management (kudos to GuruFocus author Chandan Dubey, who recently highlighted the unjustifiable compensation packages at FCX).
As the Arab Spring has shown, the people must demand that they are heard. For the first time, technology has provided the investment community with the ability to both retrieve and discuss corporate injustice on a scale unfathomable just 30 years ago; as investors, we will collectively decide whether we want to push the board of directors and managers across corporate America towards a system of stronger governance.
About the author:I'm a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves. As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-10 names; from the perspective of a businessman rather than a market participant / stock trader, I believe this is more than sufficient diversification.
I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over a period of many years.